Prime Lenders Adopt Risk-Based Pricing

2007-03-08 10:33:40

( Financial )



Prime lenders used to price loans differently from sub prime lenders. You usually had prime lenders imposing an average cost pricing policy on their loans.

Under this pricing method, prime mortgage lenders charge your loan the same interest rates and fees as all other borrowers, without considering differences in your individual risk profiles. If you fall below the prime lenders’ standards, they deny your loan.

Sub prime lenders, on the other hand, practice risk-based pricing. In this method, your sub prime lender charges an interest rate and loan fees on your sub prime loan different from other borrowers. The price will depend on how good a credit risk you are: the sub prime lender will charge good credit risks lower interest rates and fees than poor credit risks. Only exceptionally bad credit risks are denied loans.

However, prime lenders are now practicing risk-based pricing. The advent of automated underwriting systems has made it comparatively easy for prime lenders to draw fine lines of distinction between low- and high-risk borrowers, and they now price your loans accordingly.

Advantage of Risk-based Pricing

You will see that risk-based pricing implies that more loan applicants are able to obtain financing. In a way, the method is fairer than average-cost pricing, because the low-risk borrowers do not subsidize those with higher risk.

Disadvantage of Risk-based Pricing

You may see some borrowers who cannot qualify for the best rates priced out of the market, if they can no longer afford the cost of borrowing. You may get a little confused with risk-based pricing when you do comparison shopping, since prime lenders and sub prime lenders cannot advertise a single interest rate for all borrowers.

Risk-based pricing has become more established in the prime market. This is a sea change for the industry, and it blurs the distinctions between prime lenders and sub prime mortgage lenders.


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