Howdy BOLers,

I'd like to know how other banks price their consumer loan products. We are about a $500MM community bank, for context.

Currently we have a consume product list with one rate/term/LTV/etc. You either get the rate or you don't (or at least that is how the guide reads). I'm trying to work with management on developing a more objective pricing method that will allow for tiered pricing. Management wants the flexibility to offer A credit to A borrowers and B credit to B borrowers, etc. We are running into issues where pricing exceptions are being made and they aren't necessarily equal in all cases.

How are the rest of you pricing your consumer products? Credit score only or multiple factors?

Thanks.

Set your target profit margin. Determine your loss rates between the categories of your customers that you want to tier. Set interest rates accordingly.

We generally tier our interest rates based on credit score and LTV. You can based interest rate on several different factors, but we've found that it can get really complicated when too many factors are considered.

NP, many banks have risk based pricing (and loan terms) based on credit score. Higher can also factor in longer terms, higher LTV, etc.

Randy gave the short answer. Identify the margins, taking into account some data, which could come from your credit bureau about the potential higher costs of collecting, servicing, charge off, etc. Analyze the traunches (ranges), and be careful how they are explained to an examiner.

One [trick] question I've actually heard is an examiner asking an EVP credit about credit scores. Asked if 1 point in a credit score was meaningful. The follow-up question was if it is not really meaningful, why is there 1/4% difference between the rates for a 719 and 720? The bank had the data from the credit bureaus broken down into ranges, risk, etc. The same question could be 719 max auto loan was 60 months vs. 72 months for a 720+. (Also cutoff for making - 619=no, 620=yes.)

Our approach is similar to what Matt and Rocky describe. We use cost of funds and required margin to set the minimum acceptable rate for high credit quality borrowers with short term loans, then there are price bumps for various score bands, longer terms, higher LTV, etc. Required margin can vary by business unit, with riskier businesses having higher minimums.

For trick questions like the one Rocky recounted, one potential answer is to explain that credit scores effectively rank order risk, so yes, a 719 is riskier than a 720. Another is to explain the odds ratio for the scores in question to the examiner. On average, the probability of default doubles for every 20 point change in FICO. Higher probability of default means higher associated costs of servicing, collections, etc. Higher PD also means higher risk, which justifies the bank requiring greater return for that additional risk.

Don't forget that moving to a risk-based pricing system means adding the risk-based pricing disclosure.

For our consumer auto loans, we currently have risk based pricing. We have 3 tiers for pricing based on scores, and our rates are dependent on the model year of the vehicle (currently 4 ranges for model years). The bank wants to implement a 5th range for model years that will go up to 84 months (currently we only go to 78 months). This new range will only have 1 pricing tier (710+ credit score) and a $25,000 minimum loan amount. Does anyone see any fair lending issues with this (disparate impact) or does anyone currently do anything like this?

I don't see an issue - but again, document why there is a $25,000 minimum, and high credit score. This could include cost to service over a 7 year period, and the potential risk over the period of time.

Thank you Rocky. A similar scenario:

We have 3 tiers for our boat loans that are based on credit scores, model years will determine what the rate is, and the term is based on amount financed. The bank wants to implement the same structure for terms on mobile homes. Two of our branches are in a market along a lake, so mobile homes sell for high dollar there. We also have branches in rural areas where people live in mobile homes that are not in the best condition and sell for less. Does anyone see an issue with structuring the term on loan amout (ex. 2500 - 15k = 84 months; 15.1k -25k = 144 months; 25.1k - 50k = 180 months; 50.1k+ = 240 months)?

JMHO - Determining term on the loan amount might be a problem. It should be based on how fast your think the collateral value is going to deteriorate. Otherwise you make the lower cost housing more unaffordable.