This is the most common phone inquiry I get. “Hello, my name is Bob, and I’m writing from Somewhere, Texas, to inquire about the current interest rate on a home loan.”
That is a reasonable inquiry. How are rates determined, and why would one borrower’s rate differ from another’s even if they had identical credit scores? Today I thought I’d clear up a common misconception about mortgage rates by explaining the additional criteria banks employ besides credit scores.
How do banks determine mortgage interest rates?
In a nutshell, the mortgage rate is set based on the loan’s overall risk and the state of the economy.
You could get a better interest rate on a mortgage if rates were about 4% instead of the current mid-6%, as they were just after 9/11. This is an illustration of the impact that macroeconomic factors have on rates. It would get too complex if I went into how the mortgage-backed bond market determines the cost of mortgages right now.
Rates are based mainly on the risk associated with the loan and the state of the economy.
Note how mortgage rates rise in response to good economic news and fall in response to bad news. Although not always the case, this is a solid rule of thumb. This is why getting in touch with a seasoned mortgage professional is essential. There is a risk that the loan will not go well if your mortgage professional gives you a rate without researching the market and your specific situation.
Unlicensed or inexperienced bank loan officers can only provide you rates and have no idea whether or not now is a perfect moment to lock the deal. They probably have no idea what economic events can cause a change in your rate. Not usually. If your payment unexpectedly goes higher, you should know what’s occurring in the mortgage market, and an experienced mortgage professional can fill you in. In the case of jumbo mortgages, this is especially true. An increase of 25% might result in a $100 bonus.
How do banks determine mortgage interest rates?
Financial institutions weigh five main areas of risk to determine how much to charge for a house loan.
How to Start the Process of Getting a Home Loan.
How long have you been working there? Someone starting a new career is seen as a more significant threat than someone in the same position for 25 years. Most financial institutions require at least a two-year work history.
Most banks want a credit score of at least 620; I’ll explain why later. There was a time when a credit score of 570 would have gotten you a 100% mortgage, but those days are long gone. Banks today need a credit score of 620 or a 20% down payment. Private mortgage insurance (PMI) firms will not insure a loan of more than 80% if the applicant’s credit score is below 620. Loans with more than 80% loan-to-value ratio require private mortgage insurance.
Lending market shifts are typically attributable to private mortgage insurance (PMI) providers. For instance, when banks relax their overall loan requirements, it’s because private mortgage insurance (PMI) providers have tightened or loosened their standards, and the banks are only following suit. What a significant part PMI businesses play in the mortgage market is one of the industry’s best-kept secrets. They primarily influence the lending standards of financial institutions. You may have picked up that whenever Jim Cramer of Mad Money discusses the mortgage industry, he inevitably talks about PMI businesses.
Do you remember when most commercial banks stopped offering 100% loans? You can now understand why banks stopped providing such loans: PMI providers stopped insuring them. A higher risk is associated with an uninsured loan. When a PMI company goes out of business, the banks frequently follow suit since they prefer not to lend to borrowers with poor credit.
Also, as a mortgage broker, I continue to provide 100% mortgages, albeit in the form of an 80/20 split.
The ratio of one’s debts to one’s income is crucial. You should treat this as seriously as you would your credit score. DTI, DR, and “Debt Ratio” are some of their alternative names. Consider this your income-to-debt ratio. A debt ratio of 50% would be calculated as follows: annual income of $10,000 and $5,000 in essential debt. The preferred debt ratio range among financial institutions is 40–45 percent.
A minor annoyance is a phone call asking, “What’s your rate-I? Have excellent credit scores.” My standard response is, “That’s great, but how are your Debt to Income ratios?” Because even if a young adult’s credit score is 800, that doesn’t mean they’ll be able to buy a house. No. Why? Because, in most cases, money is an issue.
Because of this, most reputable mortgage brokers require a comprehensive application. Because we enjoy spending money on credit reports, getting pay stubs, etc., mortgage professionals don’t ask you all these questions. We want to guarantee a smooth funding process when we give approval letters.
The Loan-to-worth (LTV) Ratio is the loan’s dollar amount divided by the residence’s appraised worth. With a 5% down payment on a home that costs $200,000, the loan-to-value (LTV) ratio would be 95%. Institutions typically require a down payment of 3-5% of the total. However, the best rates are only available with a 20% down payment.
Whether or not a person is approved for a mortgage depends on their credit score, debt-to-income ratio, job stability, private mortgage insurance (PMI), loan-to-value (LTV), and PMI.
Now that we’ve covered the fundamental five, we can discuss the loan’s overall risk and the components determining the interest rate.
Income and Employment Verification: Has the statement “Show me the money!!” ever crossed your mind? Banks not only care about your income and payment method when you’re purchasing or refinancing a home. Do you prefer a W2 or 1099? Can you provide me with tax returns or proof that you are self-employed? Banks typically view loans made to w2 employees as the safest bet. Foreclosure rates are lower for these loans since they are “Full Doc” loans, requiring extensive documentation from the borrower.
The more significant the risk, the less a bank wants to see proof of income. Remember that the riskier the situation, the higher the rate will be.
Most of the current wave of foreclosures stem from the 100% loans for which the bank didn’t insist on proof of income. They relied only on the customer’s word. And now the costs are high for the banking industry.
However, a lack of income proof does not necessarily indicate a high-risk borrower. Due to the usual deductions made for business expenses, self-employed people typically cannot prove the total amount of their income.
The bank typically approves the loan even if I can’t prove the client’s income; they want a 5-10% down payment. Because of the increased risk involved with these loans, the interest rate the bank charges me is more significant when I cannot provide proof of income for all of my clients.
There are situations when the requirement to prove income is overly stringent. A doctor I formerly worked with made $200,000 per year at the hospital, but after opening his own business, he was assured $400,000 in salary over the next two years. May I lend him the money? NOPE! The bank refused to consider his new 1009 income from self-employment unless I could prove a two-year track record.
The optimum size of the loan is $. $417,000. Standard mortgage rates apply to loans of $417,000 or less. A jumbo mortgage exceeds $417,000; as you might expect, jumbo loans have higher interest rates.
The reason for the $417,000 is beyond my comprehension. Someone, somewhere, probably wanted to celebrate their April 17th (4/17) birthday by enacting this rule.
Let’s pause here and look at these two persons to discover why mortgage rates might vary so much between identical twins.
Michael and William: Their credit scores are each 800. However, the average income for a person is $200,000. However, Mike hopes to put 20% down on the house and has a W-2. Maybe he charges 6.25 percent.
However, flamboyant Billy wants to buy a $500,000 (jumbo) home and demands 100% financing. Since he is applying for the riskiest type of loan—a 100 percent financing jumbo loan—his interest rate could be as high as 8 percent.
The loan amount and loan-to-value (LTV) ratio can significantly impact interest rates, so two twins with perfect credit might get vastly different offers.
When the LTV ratio is above 90%, banks often need a 3-5% down payment. Rates increase when the loan-to-value ratio is above 90% or less than 10% of the purchase price is paid upfront. The lower the down payment, the higher the interest rate. Cost is proportional to Danger.
A higher interest rate is associated with a lower down payment (e.g., 5% vs. 10%). That’s why the 5% down payment is better than the 100% or 80/20 loan in terms of interest rate.
10% down, 5% down, 0% down — lower rates available. Costs Go Up.
Having a debt load greater than 45% of one’s annual income is problematic. So, if your debt-to-income ratio is 50%, you might have to pay more than if it were 30%. You may not get the loan if your debt-to-income ratio is between 55% and 60%.
Before all the recent foreclosures, it wasn’t that important where a house was located. However, nowadays, banks restrict the LTV of your loan depending on the property’s location. There aren’t many “foreclosure hot spots” in Texas, but other states, like Florida and Las Vegas, feel the impact. Most banks will set a lower restriction on your loan of around 5 percent if your home is in a declining region. If you ordinarily only need to put down 10% to get a loan, the bank will cut your loan amount to 85%, leaving you with a 15% down payment plus closing expenses.
Single-family homes offer more affordable rates than duplexes.
Credit scores: 620, 660, 680, 700, and 720 are typically considered good credit. It’s possible to get 100% financing or a mortgage with a score in the 700s and 720s. You’ll need a 660 to get into those other programs. If your credit score is below 680, you should expect to pay a higher interest rate from most institutions. You may be able to get a 3% down mortgage if your credit score is above 640, but the interest rate may be higher.
Banks favor escrow arrangements in which taxes and insurance premiums are paid in advance to the bank. Naturally, if you want to “waive escrow” and pay your taxes and insurance, you’ll have to pay higher interest rates because you’re exposing the bank to the risk of a tax lien. This “rate hit” often amounts to 0.25%.
Several factors are considered when determining your mortgage interest rate, and we’re here to help you navigate them. Whether you’re a first-time buyer or looking to refinance, Mylendingplace.com is here to help. Please visit our website or click on the Texas Mortgage Refinance Application to begin the pre-approval process.
If you need assistance anywhere in the Lone Star State, dial 512-996-8194.
Austin mortgage broker Jon Spears [http://www.mylendingplace.com/] works with Texans nationwide to get them into homes they can afford. He also assists clients in obtaining Austin, TX, home equity loans for debt consolidation [http://www.mylendingplace.com/]. He aids customers in achieving their retirement goals by providing them with various lending options, including purchase loans, home equity loans, and loans to purchase or refinance investment properties.
He has been in the mortgage business since 2005 through his company, mylendingplace.com, and has closed loans totaling several million dollars. His direct line is 512-996-8194.