Because Fannie Mae financing is so dominant in today’s mortgage market, it’s important that real estate investors understand how Fannie prices risk into mortgage interest rates using loan-level price adjustments, or LLPAs. Once you understand how risk-based pricing works, you’ll be better equipped to “groom” your financial profile to qualify for the best rates and maximize the cash flow and ROI of your bank-financed real estate investments.
What is an LLPA?
LLPAs are essentially charges for risk factors such as low credit scores, high loan-to-value (LTV), property type, etc. Check out the image below, which shows a variety of LLPA hits for various combinations of credit score and LTV. Note that for a 95% LTV loan, there is a 3.000% hit for borrowers with credit scores less than 620 but no hit for borrowers with credit scores better than 740. Assuming all other factors are the same, this means that the borrower with a qualifying credit score of less than 620 will have to pay a charge of 3% of the loan amount to get the same interest rate as the borrower with a 740 credit score. For example, on a $200,000 loan, the borrower with the low credit scores would have to pay a $6,000 buy down fee to get the same rate as the borrower with the good credit scores.
Though LLPAs act like fees, they usually are not passed on to the end borrower as additional closing costs on the loan. Lenders typically price LLPAs into the base rate they offer, so the end result is that LLPA hits usually result in higher rates instead of higher fees.
Now, check out the chart below, which shows the LLPA hits for investment property (highlighted in red). As you can see, the hits are steep, and they’re a standard charge applied regardless of credit score. If you’re willing to put down 25% (which means a 75% LTV), the LLPA hit is a relatively modest 1.75%. However, if you’re only willing to put down the minimum 15%, the LLPA hit is a whopping 3.75% (not to mention you’ll pay mortgage insurance because the LTV is over 80%).
Why LLPAs Matter to Real Estate Investors
It’s obvious that Fannie views investment properties as riskier than owner-occupied properties, particularly those with little equity. These LLPA hits are the reason investment property rates tend to be significantly higher than owner-occupied rates.
If you haven’t noticed already, credit scores are a big part of LLPA pricing. If your credit scores are in the mid to high 600 range, you’re going to get hit with some significant LLPAs unless you owe less than 60% of the value of the property. This is why it’s important to keep your credit scores as high as possible – ideally above 740.
If your plan is to purchase a property with short-term financing such as private or hard money, it’s also important to make sure you’re buying your properties right so that you have a built in equity position when you need to refinance into a traditional bank loan. For instance, if you purchase a fixer property with hard money, rehab it, and still have a 30% equity position in it when you’re done, it should be relatively easy to convert the hard money loan into a permanent bank loan.
There’s a lot more that goes into pricing out a loan, so it’s important to work with a mortgage professional to get information specific to your particular situation. If you’re looking at financing residential investment real estate (4 units or less), feel free to give me a call.
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