Savvy borrowers know their PNPs

Flickr image by normanack.

PNP, which stands for "pricing notch point," is a value of one of the factors used in pricing goods at which the price changes. In most lines of business, the factor used to price is the quantity purchased. For example, at the farm stand where I buy corn, the price is 70 cents an ear for the first three ears, 65 cents for the next three, and 60 cents for any ears beyond six. This merchant's PNPs are three ears and six ears. These PNPs are pretty easy for consumers to understand, but the stakes are small.

In the mortgage market, PNPs are more complicated but the stakes are high. On a mortgage, the "price" includes the interest rate, mortgage insurance premium and points -- any or all of which can change in response to changes in loan size, loan-to-value ratio (LTV) and credit score. Each of these has its own PNPs.

As examples, on Sept. 18, 2009, the interest rate on a 30-year prime fixed-rate mortgage (FRM) at zero points was 4.75 percent for a loan amount of $417,000, and 5.375 percent on a loan of $417,001. In this case, $417,000 is a loan-size PNP.

On a prime 30-year FRM, the monthly mortgage insurance premium was 0.69 percent at an LTV of 85 percent, and 0.88 percent at an LTV of 85.1 percent -- with 85 percent being an LTV PNP.

The same mortgage with a rate of 4.875 percent had points of 0.3 percent with a FICO score of 720, and points of 0.8 percent with a FICO of 719. Here, 720 is a FICO-score PNP.

Since the increase in price that results from crossing a PNP applies to the entire loan, not just to the increment, the increment can be extremely costly. While no one would borrow $417,001, as in the above example, they might borrow $500,000. In that case, the cost of the $83,000 increment would be 5.375 percent on the increment, plus an additional 0.625 percent on the $417,000. The moral is that you don't pass a PNP in the wrong direction if you can possibly avoid it. ...CONTINUED

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