“I thought I found the perfect mortgage,” Marie said. “The interest rate was low, and the terms were good. But when I got to closing, I discovered a fee called an LLPA that added another $3,000 to my loan.”

Marie’s story is not unique.

Loan-level pricing adjustments (LLPAs) are a common "quirk" that can cost you thousands of dollars over the lifetime of your mortgage.

In this article, you'll learn what they are, how they are calculated, and how to minimize them.

What is an LLPA mortgage?

An LLPA is a risk-based pricing adjustment used to assess borrowers who are taking out conventional mortgages.

It permits the lender to charge more for those with a higher risk profile without penalizing low-risk borrowers.

Consider a homebuyer with a 750 credit score, aiming to purchase a $300,000 house with a 30% down payment. Due to their strong credit and substantial down payment, they might receive a lower LLPA rate of 0.25%, resulting in just $525 in LLPA fees.

For example, a borrower with a credit score of 620 who needs a loan to pay for 80% of their property might pay an LLPA of 1.5%. In that case, for a $200,000 house, they would pay an additional $2,700 in LLPA fees.

An LLPA is like a slider that moves higher or lower depending on your risk profile, impacting your mortgage interest rate, closing costs, and monthly repayments.

While LLPAs aren’t physical entities, they are integral to the financial mechanics of your mortgage, shaping the financial terms of your home loan and your future.

A brief history of LLPAs

LLPAs are primarily the result of the 2008 financial crisis when the subprime mortgage market collapsed. The subprime mortgage market provides loans to borrowers with poor credit histories.

When these borrowers defaulted on their loans, it caused a devastating ripple effect throughout the financial system, weakening the mortgage industry.

As a result, Fannie Mae and Freddie Macthe two government-sponsored enterprises that provide liquidity, stability, and affordability to the mortgage marketimplemented LLPAs to prevent another financial crisis.

Rather than charge a blanket fee, they adjusted it according to risk level. Consequently, LLPAs can bump your mortgage rate by 1% or more.

How LLPAs are calculated

The exact formula for calculating LLPAs depends on each lender. Generally, they will assess your risk profile and add a percentage point or two to the interest to compensate for that risk.

  1. Credit score: As with most financial instruments, borrowers with poor credit scores are at higher risk and, therefore, charged higher LLPAs
  2. Loan-to-value (LTV) ratio: A metric expressing the relationship between a mortgage and your property's appraised value or purchase pricewhichever is lower. The higher the LTV, the higher the LLPA
  3. Property type: LLPA adjustments only apply to Fannie Mae and Freddie Mac loans and not loans backed by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), or the U.S Department of Agriculture (USDA)
  4. Debt-to-income ratio (DTI): While not as common as other factors, some lenders might weight your income against any debt you owe. A higher DTI means you have more debt, which makes you a riskier borrower

How LLPAs can affect your mortgage

LLPAs can have notable effects on your mortgage. First, they contribute to increased closing expenses, by adding items like origination fees, discount points, or interest rate adjustments.

Additionally, some lenders may allow you to absorb your LLPA through a heightened interest rate, potentially leading to larger monthly mortgage payments throughout the loan's duration.

Furthermore, the extent of your LLPA and your financial standing can influence your loan's affordability and, in certain instances, may even impact your eligibility for a loan.

2023 LLPA adjustments

As of May 2023, the Federal Housing Finance Agency (FHFA) announced a new set of pricing adjustments to LLPAs that make the mortgage market fairer and more transparent.

Besides credit score, your LLPA is largely based on your loan-to-value ratio, meaning it’s based on the percentage of your home’s purchase price that you’re borrowing.

So, if you have a loan-to-value ratio of 80%, your LLPA would be higher than if your loan-to-value ratio was 65% because you are borrowing a larger percentage of your home’s purchase price.

The greater your down payment, the lower your loan-to-value ratio.

Lenders are now also required to disclose LLPAs in addition to the interest rate on the mortgage.

In the past, the LLPA wasn’t always listed separately from the interest rate, making it difficult to determine how much LLPA added to the total mortgage cost.

According to CBS News, “The updated fee only impacts homebuyers and doesn't impact people who already have a mortgage or own their homes outright. It also won't impact the roughly 40% of mortgages that Fannie Mae or Freddie Mac doesn't back.”

How to avoid mortgage LLPAs

The only way to circumvent LLPAs is if you qualify for one of Fannie Mae's specialized loan programs.

Fannie Mae offers full LLPA exemption to:

  • Individuals falling within the low-income criteria established by Fannie Mae
  • Those who satisfy the prerequisites of Fannie Mae's HomeReady program
  • Loans that fulfill the "Duty to Serve' mandate encompassing loans extended to underserved rural areas, Loans for Native Americans residing on tribal lands, and loans intended for affordable housing preservation

If you don't qualify for exemptions, consider making the largest down payment you can comfortably manage, maintain a high credit score, and reduce any additional debt.

LLPAs are different for everyone.

Your interest rate and LLPA options will remain uncertain until you complete a mortgage application and secure pre-approval.

So, make sure to compare LLPA fees in mortgage offers to secure the best deal for your needs.