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What is A Loan Pricing Program?

Author: Frank Shields

Loan pricing plays a vital role in the lender's asset/liability management program with loan pricing decisions having a direct effect on credit risk and earnings. Lenders must price their loans appropriately, ensuring that all costs are covered, risk is accounted for and managed, and sufficient capitalization is available for the lender's long-term viability. In addition, the loan pricing must also consider competitor rates as well as meet the borrower's needs. Like other competitive products, pricing requires a delicate balance between meeting organizational and borrower needs.

Not only is loan pricing crucial to the financial institution's success, FCA regulations require lenders to have formal loan pricing policies in place that cover everything from loan types offered, factors involved in computing or adjusting interest rates, and compliance policies to methodologies for monitoring loan pricing and loan pricing policy compliance.

Lenders create internal loan pricing programs to ensure regulatory compliance as well as help loan officers make the best pricing decisions possible. While each institution can adopt their own methodologies, most loan pricing programs address the following factors:

• Cost of funds — These costs are usually identified and determined by the bank's treasury department.

• Cost of operations — These costs are the institution's operating costs such as rent, salaries, insurance, training, IT infrastructure, and so on.

• Credit risk requirements — All loans are inherently risky, with some loans riskier than others based on the borrower's credit history and other factors. Credit risk requirements are used to ensure that interest rate charged reflects the level of risk assumed (i.e., riskier loans have higher interest rates).

• Customer options — Loan pricing programs often allow for customer options such as caps on interest rates or prepayment rights. These options add risk which should be priced into the loan product.

• Interest payments / amortization — How interest is applied to a loan and how the loan amortizes can affect earnings and profitability.

• Capital investments or "loanable funds" — This refers to how much the lender has invested in loans, and thus, the amount it must borrow to fund operations along with its loan portfolio.

• Capital and earnings requirements — Lenders must understand their capital and earnings requirements in order to establish an effective earnings strategy, which plays an important role in loan pricing.

Each lender has its own loan pricing program based on its unique needs and strategies. Some use simple methodologies (such as matching the competition) while others use more complex models. Loan pricing models can assist lenders in establishing loan prices. These often take the form of a spreadsheet or calculator program. The loan officer simply inputs information and the program calculates the appropriate loan rate based on the information contained in the pricing model such as interest rate, fees, projected loan volume, loan terms, cost of funds, operating expenses, and so on.

Specialized loan pricing software that goes much deeper than a simple spreadsheet or loan calculator is also available. Loan pricing software can ensure that the requirements established in the formal loan pricing policy are consistently followed. With such as system in place, loan officers can quickly price loans that comply with the institution's formal loan pricing policy.

Article Source: http://www.articlesbase.com/loans-articles/what-is-a-loan-pricing-program-6642420.html

Frank J Shields is the author of this article explaining what a loan pricing program is. Loan and mortgage software are the main drivers of loan pricing programs today and this article explains how they work.

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