How LLPAs came to be:
We all remember the time when mortgage pricing did not come with many rules. Government-backed loans began to break down and with very little regulation in place, lenders were able to easily manufacture high-risk subprime loans, and they were able to do it often. It wasn’t until the global financial crisis of 2008 that risk-based pricing was formalized by Fannie Mae and Freddie Mac.
The introduction of this legislation had two lasting effects. First, there is now much more guidance on exactly what level of risk can be associated with each loan. It has been made explicitly clear what types of loans are absolutely unacceptable. Second, risk-based pricing has been cemented into the mortgage loan process.
When you take pure risk-based pricing to the next level, you get LLPAs.
What are LLPAs?
Loan-level pricing adjustments (LLPAs) are exactly what they sound like. They are adjustments made to the price of the loan which ultimately impact the rate and fees a borrower is required to pay for a mortgage. Similar to car insurance, the riskier the borrower, the higher their costs. LLPAs are based on certain risk factors applicable to a mortgage, such as a low credit score, high loan-to-value (LTV), type of occupancy, and more. Further, LLPAs are calculated using overlays in the mortgage pricing process and equate to a percentage value of the total loan amount.
Why use LLPAs?
Without LLPAs, lenders are left with simplistic, base pricing. While a very basic pricing approach might work just fine, lenders that wish to become more advanced in their mortgage pricing strategies should be able to identify areas of price sensitivity where they can be more productive in terms of price or margin management.
When pricing a loan, lenders can use LLPA overlays to create offsets to price the number of adjustments on each customer segment up or down based on how competitive and/or price sensitive that area is. LLPAs are an easy way to account for specific granular adjustments and they can be applied as needed—be it finitely or in a temporary capacity. By utilizing these small adjustments, lenders can get a little more or a little less volume to attain the margins they desire. With LLPAs, risk-based pricing and price sensitivity can be evaluated in tandem, resulting in a confluence model between risk and price sensitivity.
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