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If you are in the small minority of prospective home buyers that shop for a loan among several different lenders, you might have realized that they don’t all offer the same mortgage interest rate. The “costs” associated with each loan may actually differ significantly depending on the mortgage loan being offered.
Why do lenders sometimes offer different terms to a borrower whose qualifications are exactly the same on each loan application they fill out?
To help you understand the justification used by lenders for doing this, it is first important to look at why different rates are offered by lenders to different applicants and then look into why they sometimes present different offers to the same applicant.
Why Do Lenders Set Different Mortgage Interest Rates for Different Applicants?
The mortgage rate that an applicant qualifies for differs with each applicant. Various factors are used to determine the mortgage interest rate the applicant qualifies for. Debt-to-income ratio, credit score, and the size of the down payment are the largest determining factors. Other factors still play a role in determining what lenders are willing to offer, but these 3 hold the most leverage.
While one applicant may qualify for the lowest rate of just under 3 percent, another may qualify for a rate of 3.5 percent. The loan term offers presented by a bank to an applicant will depend on their personal financial factors when they apply for the loan. The applicant’s financial data paints a picture of the risk to lend them money from the perspective of the lender.
Lenders will typically offer higher interest rates to borrowers they consider more riskier to loan money to. Borrowers with past due payments on credit reports, low credit scores, or those taking on a higher debt-to-income ratio will be viewed as a higher risk and consequently offered a higher rate of interest.
Why Do Different Lenders Offer the Same Applicant Different Mortgage Interest Rates?
Each individual lender starts with a basic model used by all banks to assess risk. The models are actually set by financial giants such as Freddie Mac and Fannie Mae that purchase loans from banks after they are made. If the loans fail to meet these standards, then they won’t be purchased.
Besides the qualifications that are set as standards by the aforementioned big loan purchasing companies, each individual lender actually sets their own standards above and beyond those that have already been set. Simply put, each lender has its own specific model for assessing an applicant’s risk for loaning money to.
One lender might be more interested in the credit score while another considers debt-to-income ratios more important when considering what to lend out, while yet another lender might feel that the size of a down payment is more important. These are known as mortgage overlays, which are the specific rules a lender sets on their own above the standard.
The loan type also makes a difference in the interest rate offered. Lenders usually put a higher rate on a mortgage with a longer life term. For instance, a 30-year loan will generally have a higher interest rate than a 15-year loan. A zero down loan will also attract a higher rate of interest than a traditional mortgage.
Besides looking at the interest rate, it is also important for borrowers to look at all the fees and costs associated with the loan they are considering to determine the actual overall cost of the loan and what is the better option.
Working with a mortgage broker allows borrowers to see all of their options in one central location and lets them ask a trusted professional about the various options of each loan in one convenient place.