December 12th, 2014 6:06 AM by Jackie A. Graves, President
When you apply for a loan, you need
to submit a ton of documentation and
answer a bunch of questions from your lender.
Turning over all this information about your personal finances and
financial history may seem intrusive, but it makes sense: The lender
needs to gather all the information they can to decide on the interest rate for
But how do they take all your information and come up with a figure?
Balancing Profit and Competition
Lenders must strike a tough balance between being competitive with
other firms and assessing the risk involved with loaning you money. If they try
to charge borrowers too much, they’ll lose clients. However, if they charge too
little, they’ll likely run into financial ruin.
There was a time when lenders would consider loaning money to borrowers
who didn’t put any
money down. This was extremely risky for the lender, because the
borrower didn’t have a true stake in the home. There was a higher
likelihood the borrower would walk away from
their loan if they got caught in cash crunch.
Today, lenders look at down payments differently. If you’re willing and
able to invest a large
down payment in your home, the lenders assume less
risk and will offer you a better rate. A 20% down payment makes a
lender feel much more secure than a 10% down payment.
Credit score is another key factor in determining your interest rate. A high credit
score shows you’re a responsible borrower, and lenders are more
confident in loaning you large sums of cash with a lower interest rate.
If your score is low,
the lender’s risk factor goes up. As a result the lender will charge you more
to loan you money. If your score is too low, they’ll consider you a
risk and decline your
Purpose of the Home
If you plan to live in the home, you’ll get a much better rate than if you plan to
rent it out. Looking at it from a lender’s point of view, a person
living in a house and making it into a home is much more likely to work hard to
make the payments to keep the property.
A person who’s purchasing a house purely for investment may
stop making payments if their financial situation worsens. It isn’t their home,
so they aren’t emotionally invested.
There are many kinds of
mortgage loans, and some are riskier for the lender than
others. For instance, if you secure a 15-year loan, you’re agreeing to pay
back the money faster than someone who opts for a standard 30-year loan.
For this reason, lenders consider a 15-year loan less risky and are likely
to offer you a better interest rate.
If you desire a fixed-rate
mortgage, lenders will charge you more. They are guaranteeing you
that rate, so they need to compensate for any risk.
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