I generally have to deal with the hard questions as am a president of a midsize manufacturing company. As usual, our finance department queries me about ‘Loan Level Price Adjustment’ which seemed to be impacting our cash flow. I’ve frequently dealt with these adjustments before. So, I am quite excited to learn still more about them. In this blog post, I will share from my experience about loan level price adjustment.
This is what I learned…
What is a loan level price adjustment?
A loan level price adjustment (LLPA) is a way that lenders can reset the price of your loan. As a result, you get payment of a higher interest rate or a lower interest rate. They can make your payments lower or higher if they want.
When you make an application for a loan, the lender effectively pushes it to their rate floor or ceiling. That means that the lending institution is only willing to lend you money if they get payment of a certain amount of interest on those funds. Lower down-payment loans are more likely to get sold at a rate lower than the lender’s ceiling; and vice versa.
So if someone applied for a $100,000 loan with $20,000 down (a 80% loan), the lender would likely require some sort of interest rate of about 6% or so in order for them to be willing to accept your application.
Now let’s imagine that the day after you got the loan, interest rates dropped by a full percentage point. If that happened, your lender would likely want to reset your interest rate to whatever their new rate floor is (7% in this case).
Because they gave you a loan when they were charging 6%, they’re entitled to adjust your payment amount so that it reflects what it would be if they charged 7%. So as a result of that adjustment, you might end up paying $100 more per month for the next 30 years! That’s how lenders can raise your interest rate – and it can really eat into your cash flow.
However, lenders can do the opposite if rates have gone up. If rates go up by a full percentage point, your lender is justified in increasing their pricing to reflect that higher rate. If you applied for a $100,000 loan with $20,000 down (a 80% loan) and the lender was charging 7% and rates went up to 8%, they would be justified in raising your payment amount from $80 per month to $160 per month.
What’s the average loan level price adjustment?
Generally speaking, it’s a negative number but it can vary based on market conditions or other factors. For example, if you need a $100,000 loan and the rate is 6%, lenders are likely to adjust your interest rate downward to 5%. But if rates fall to 4%, it is likely that they will adjust your interest rate downward to 4%.
But since I’m a little bit of a freeloader, I don’t have time to figure out the ‘average’ and I suspect that no one really knows. My rule of thumb is that the average is probably closer to zero, but it could be as high as 1% or 2% (encouraged by low interest rates), or even more in some cases.
One thing is for certain – you don’t want a loan level price adjustment! The good news is that 99% of these adjustments are negative, so at least you’re not likely to have a big, positive number popping up all of the time.
Why do loan level price adjustments happen?
There are two main reasons why lenders adjust your payment:
- The first is that they want to compensate you for the fact that they gave you a loan at a lower interest rate than they would have otherwise charged. If you got a loan in December 2015, your interest rate was likely lower than if you had applied for the same loan in December 2014. So lenders like to compensate you for their generosity, so to speak. And that’s what these negative adjustments are – a way of ‘giving back’ some of their earnings from pre-2014. On average, I would estimate that 2/3 of all adjustments are negative and 1/3 are positive .
- The second reason for an adjustment is that lenders can use them to protect against higher than expected losses. If your income suddenly goes down, they can adjust your payments downward so they’re not losing money, even if your original interest rate was lower. This is the most common reason why there are positive adjustments. Lenders want to protect themselves from heavy losses, and those losses are often consequences of unexpected job loss. So, if you get laid off and your income drops by 50%, they want to be able to reduce your payment so they don’t lose money on the loan. And that’s usually how positive adjustments occur – when something bad happens with the borrower (a job loss, a foreclosure, etc).
Is loan level price adjustment tax deductible?
Yes, if you itemize your deductions. So if you’re trying to decide whether or not to ask for an adjustment, the answer is that it depends. If you get it, you’re getting compensation for giving away some of your earnings at a low interest rate, but you’ll have to pay Uncle Sam a pretty big bill for the privilege.
And since I like being generous with the government, I usually request these adjustments no matter what. And if I can get them in addition to a loan forbearance or deferral, even better! The majority of lenders will let you do this (it’s in their best interest) and it’s often completely free of charge.
What can you do about loan level price adjustments?
Because these are negative adjustments, the best thing to do is to try and keep your interest rate as low as possible when applying for a loan. The lower your interest rate, the less likely it is that they will have to give you an adjustment and the less amount of the adjustment will be negative.
If you’re worried about losing a lot of money due to price adjustments, consider making extra payments each month before any loans start adjusting. This way, your payments won’t be affected by changes in market rates, and they’ll have more time to apply towards paying off the loan.
Another good option is to make sure that you’re getting a fixed rate loan. Either a 20-year or 30-year fixed rate loan will offer you the most protection from loan level price adjustments.
Negative adjustments are a big part of the credit world, and they’re going to be around for a long time.
Some lenders are going to try and use these price adjustments to manipulate things in their favor, forcing you to pay more than you have to or earning more money in interest. And that’s why it’s so important that you know exactly how much your loan level price adjustment will cost you and what the best options are for fixing them if they happen.
Ultimately, there’s no way to avoid these adjustments if you plan on applying for a loan, which is why it’s important to understand how much they’ll cost you before you go through the process of loan shopping.
FAQs about loan level price adjustment (LLPA):
1) What is the definition of a loan level price adjustment? How to calculate it?
- A loan level price adjustment (LLPA) is essentially the difference between what a lender would have charged you for the same loan had you applied at a different time. If a lender charges 7% interest on your loan and rates rise to 8%, they’ll adjust your payment downward to $100 per month.
2) If a lender gives me an adjustment, in how many parts will it be made?
- This is usually split into two equal payments. The first adjustment is usually applied to the period before the loan has adjusted and the second part is applied to the amount of money left on the loan.
3) How do I know if I have any loan level price adjustments?
- Most lenders will inform you what your interest rate was when you took out your loan, but some do not. To find out for sure, contact your lender directly and ask about it. If they don’t have this information available, it’s almost certainly because they won’t be increasing your payment for any negative adjustments.
4) How will I know how much my loan level price adjustment is?
- One way to find out is to check your last adjustment letter. If you’re no longer in possession of this document, call your lender and ask them. The other option is to call a loan specialist and ask what they would have charged you had you taken out the loan at a different time.