Hillsborough, Burlingame Luxury Homes Real Estate

One of my favorite lenders, Brandon Hoyes, answered a question I posed to him the other day about some new kinds of lending practices I'd heard about, Risk Based Pricing. Brandon tells me this isn't new at all, and presents a good primer on lending for you in today's world. San Mateo County hasn't been hit as hard as other counties in California with foreclosures because so many people were able to buy homes and put down 20% or more to do so.  Read on and learn a little more about how mortgage lending works.  Knowledge is power.

Risk based pricing has always been a component to mortgages even during the euphoric boom of the last few years.  It has always been the case that a borrower with little or no down payment, bad credit and undocumented income is going to pay more interest than a person with stellar credit, a sizable down payment and income that can be proven.  To understand how this works, it's important to know the major factors in determining loan eligibility.  There are many, but the BIG 4 are:

• Credit - Not only FICO score but the amount of debt a person carries and what it costs on a monthly basis
  
• Income - How much a person is making and if it will remain consistent in the future
  
• Assets / Reserves - What a person has in the bank that can be used to make mortgage payments in the event of job loss
  
• Loan to Value (LTV) - What a person wants to borrow in relation to the value of the property.

When a borrower is strong in these categories, banks feel good about lending and will offer greater incentives to the borrower, i.e. lower rates and fees.  When a borrower is weak in these categories, the bank sees more risk in lending and will pass this risk on to the borrower in the form of higher rates or fees.  For example, let's talk Loan to Value. The more a person borrows against a property (higher LTV), the more risk the bank is forced to take on associated with lending.  A person who wants to put no money down on the purchase of a home (100% financing) is a greater risk than a borrower who is putting 20% down.  Banks will hedge this risk by either not offering higher LTV financing or charging a premium to the borrower for the luxury.

Loan to Value has been one of the biggest factors on the mortgage world over the past couple of years and the rapidly increasing equity market we experienced was a major fuel to our out of control mortgage fire.  We all know of property values that rose 20, 30, in some cases 40% in a 12 month period.  Regardless of policy at the time, banks felt better about lending on higher LTV loans when they knew that property values were on the uptick.  The logic being..."If I lend you money now, even though you might not be able to afford it, you always have the option of refinancing down the road and using your newly built equity to bail yourself out."

Higher LTV loans were just as risky in 2003 as they are in 2008.  Now that we have seen property appreciation slow and in many places decrease, many borrowers cannot go back and refinance to bail themselves out. Essentially the "equity well" has dried up and many are forced to sell or are subject to foreclosure.  Coupled with adjustable rate mortgages that are resulting in higher mortgage payments, many borrowers have no option but to walk away from their homes.

Going back to the 0% down vs. the 20% down borrowers, the 0% borrower has no equity in their home and essentially no financial investment in their property.  They are more apt to throw in the towel and walk away than the borrower who put down 20%.  It has become a losing gamble for banks to offer higher LTYV loans and many have limited their total LTV exposure on loans to 80% or less.

If you would like to talk further with Brandon, he is a loan broker with Red Oak Corporation in Burlingame and can be reached at brandon@RedOakCorp.com.  

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