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Special Reports
Home Equity Lending
NHEMA Study Finds Loan Rate, Risk Are Linked
by Brad Finkelstein
WASHINGTON -- A study for the National Home Equity Mortgage Association states
that the interest rate a borrower pays on his or her mortgage loan is directly related to his or her credit risk
profile.
A second study said putting a prepayment penalty in the loan agreement resulted in a lower rate for the borrowers.
NHEMA requested the law firm of Sirote & Permutt PC, Birmingham, Ala., to commission the studies, which were
done by Richard F. DeMong and James E. Burroughs of the University of Virginia's McIntyre School of Commerce.
"The question of how certain risk factors and the presence of prepayment fee clauses affect mortgage pricing
came up when I testified at House of Representatives Financial Services Committee hearings last year," said
Mr. DeMong in a statement issued by NHEMA.
"I had to admit I didn't know of any hard data on these issues .... That's when I started moving forward on
these studies. They directly address the vital questions - is the mortgage market efficiently pricing loans based
on risk? Are prepayment fee clauses on loans an option that really benefit consumers? Those questions go to the
heart of informed consumer choice and effective policymaking."
In doing the study, the pair said they expected that if there was a prepayment fee, the higher the borrower's credit
score, and the higher the borrower's monthly income, the annual percentage rate of the loan should be lower, all
else being equal.
"This was the case. The higher the FICO score, the lower the APR, all other factors held constant. The other
factors that were inversely related were monthly income, the presence of a prepayment fee and owner occupancy,
as expected. The APR of the first-lien mortgage would be lower if borrower's income was higher, if the loan had
a prepayment fee, or if the home was occupied by the owner," the report on pricing said.
Besides having a lower APR, these borrowers were able to borrow a greater amount and have a higher loan-to-value
ratio, the study concluded.
As for prepayment fees, that report said approximately three-quarters of the loans they looked at had a prepayment
fee.
"Contrary to what some have said, prepayment fees were no more likely for borrowers with low FICO scores than
high ones. In fact, for fixed-rate mortgages, the trend is clearly upward, with higher-FICO-score-borrowers more
likely to opt for mortgages with prepayment fees.
"This is substantive because it points toward prepayment fees being used by borrowers (particularly high-FICO
borrowers, who presumably have more options) to reduce the rate of the loan, as opposed to some mechanism used
by lenders to extract additional fees from those with limited options, as has been contended by some," the
report on prepayment fees said.
On average, a loan with a prepayment penalty has an APR, which is 38 basis points lower than one that does not
have one, the pair said.
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