Risk-based pricing

"Property Type" redirects here. For other uses, see Property (disambiguation).

Risk-based pricing is a methodology adopted by many lenders in the mortgage and financial services industries. It has been in use for many years as lenders try to measure loan risk in terms of interest rates and other fees. The interest rate on a loan is determined not only by the time value of money, but also by the lender's estimate of the probability that the borrower will default on the loan. A borrower who the lender thinks is less likely to default will be offered a better (lower) interest rate. This means that different borrowers will pay different rates. In theory, borrowers who are safer—or who are engaged in safer activities—should be more likely to borrow and resources should therefore be allocated more efficiently.

default prediction should be limited by ethical considerations and focus on factors that are under borrowers' control.

Risk factors

Credit score and history, property use, property type, loan amount, loan purpose, income, and asset amounts, as well as documentation levels, property location, and others, are common risk based factors currently used. Lenders 'price' loans according to these individual factors and their multiple derivatives. Each derivative either positively or negatively affects the cost of an interest rate. For example, lower credit scores equal higher interest rates and vice versa; typically, those who provide less verifiable income documentation due to self-employment benefits will qualify for a higher interest rate than someone who fully documents all reported income. Mortgage and other financial service industries value credit score and history most when pricing mortgage interest rates.

Property types

Pertaining to residential mortgages and their risk based pricing methods, the Property Type is sub-categorized as follows:

• Single Family Residence (SFR)
• Multi-Family 2-4 Units (MF)
• Townhome/Condominium (TC)

SFRs are considered to have the highest dollar value per square foot and are thus the most favorably priced of the property types in the eyes of the lending institution. The property is stand alone, or 'detached' from other property.

Multi-family and tow