How Your Mortgage Rate Is Affected By Loan To Value

Many of the home loans originated today contain higher loan to value percentages.  These loans contain inherent “risk based pricing”  higher rate for higher perceived level of risk causes rates offered to be higher.

Loan To Value Defined

The loan to value (LTV) is defined as the amount of loan you’re borrowing against the value of your the property expressed as a percentage. For example borrowing $200,000 against a property worth $300,000, translates to a 67% loan to value.  Such a loan to value is less risky to a lender.

Loan To Value effects risk the lender takes in making the loan

Risked based pricing:

The bigger loan amount relative to the valuation of the property, the higher the risk.

The smaller loan amount relative to the valuation of the property, the less risk

Loan Value Changes Based Upon These Incremental Factors:

  • Greater Than 75% Loan to Value To 80%
  • Greater Than 80% Loan to Value To 85%
  • Greater Than 85% Loan to Value To 95%
  • Greater Than 95% Loan to Value To 105%
  • Greater Than 105% Loan to Value To Infinite

Cost of risk higher loan to value loan paid by either by the lender or consumer

The risk does not just changed on more assets for example or a better credit score. The cost of risk in making the loan boils down to how the amount of money being borrowed affects the interest rate.

Lender minimizes risk by offering the consumer a higher interest rate, as a result of the higher risk, they are compensated accordingly.

Borrower minimizes risk by taking a lower interest rate and depending on the nature of the of the loan program and pays any fees to Fannie Mae or Freddie Mac in exchange for taking on the risk the lender otherwise would incur. Fees like discount points to secure a lower rate or as a function of risk brought on by LTV.

Or……

Lender and consumer mutually agree to share the risk by taking a middle of the ground interest rate.

Translation: not the highest rate,  not the lowest rate, but a reasonable rate justifiable accounting for:

  • Loan Program
  • Loan Amount
  • Property Type
  • Credit Score
  • Occupancy

Examples  of how a higher loan to value on a conventional purchase and on a conventional refinance could affect the interest rate….

Purchase Transaction

Property Value $400,000

Down Payment 5.0%

Interest Rate 3.75%

Loan To Value 95.00%

Loan Amount $380,000

Payment (P&I) $1,760

This conventional loan scenario also would include mortgage insurance as a result of the higher loan to value, lower down payment type financing. The cost of risk is two fold here; higher mortgage insurance, .25% higher in rate.

Refinance Transaction

House Value $325,000

Loan Amount $380,000

Interest Rate 4.00%

Loan to Value 117.00%

Loan Amount $380,000

Payment (P&I) $1,814

The loan to value on this refinance is under the common Harp 2 Refinance program that allows homeowners to refinance without a loan to value restriction, the risk based pricing remains the same. You’ll notice another .25% higher in rate on a higher loan-to-value refinance transaction.

Reduce costs by any of the following:

  • Reduce the loan amount/borrow less
  • If you have the cash, invest the cash into the transaction to recuperate your principal balance pay down by the interest rate and mortgage payment savings over time
  • Change loan programs-conventional loans contain the highest risk based pricing, consider a more flexible loan such as government financing
  • Finance the cost of reducing the interest rate over the life of the loan so long as you have a 1-2 year breakeven time by holding the loan/keeping the property

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