How are Mortgages Priced?
Have you ever taken out a mortgage with a lender, only to see a low rate advertised, and wonder why you didn’t qualify for this rate? Mortgage pricing most likely has a lot to do with it. Let’s look at some of the big factors that affect the mortgage rate you’ll get with lenders.
Insured vs. Conventional
When you see a lender advertise its best mortgage rate, it’s usually for an insured mortgage. Why is that? You’d think that when you’re putting less than 20% down, you’re riskier to the lender as a borrower. The reason lenders can offer you their best mortgage rates on insured mortgages is because it’s largely a risk-free mortgage for the lender.
When you take out an insured mortgage, you’re required to buy mortgage default insurance. Unlike home insurance, mortgage default insurance doesn’t protect you; it protects the lender. Should you fail to repay (default on) on your mortgage, the lender is fully protected by the mortgage default insurance provider.
This is different from a conventional mortgage when you put at least 20 percent down. If you default on this mortgage, there is more risk for the lender. If the lender cannot sell the property to recover the full amount owing, they may have to write off some of the mortgages as bad debt and take the losses.
Loan-to-value refers to the size of the mortgage relative to the purchase price (when you’re buying a home) or the market value (when you’re transferring or refinancing your mortgage). You can calculate the loan-to-value by taking the mortgage and dividing it by the purchase price/market value.
For example, if the property’s value was $1 million and you have a mortgage of $300,000, the loan-to-value would be 30% ($300,000 / $1 million = 30%).
In terms of mortgage pricing, if the loan-to-value is greater than 80%, up to 95%, it means you have an insured mortgage, and further to my last point, you’d get the lender’s best mortgage rates.
If the loan-to-value is less than 80%, generally speaking, the lower the loan-to-value, the better the mortgage rate you’ll get. If you want a lender’s best rates similar to the insured rate, generally, you’ll need to have at least 35% equity in the property.
Keep in mind that this only applies to mortgages with an amortization period of fewer than 25 years. If the amortization period is more than 25 years, the mortgage rate will almost always be higher, regardless of the loan-to-value.
Mortgage Loan Size
Some lenders even give you a better mortgage rate based on the size of your mortgage loan. For example, I’ve heard of lenders that offer you a better mortgage rate because your mortgage is over $500k.
Just keep in mind that there comes a limit. If your mortgage goes over $1 million, fewer lenders will want to loan you the money, so you might have to pay a premium on the rate.
Fixed vs. Variable
Of course, mortgage rates vary depending on if your mortgage is a fixed or variable rate. Generally speaking, a variable rate almost always comes with a lower rate.
Also, generally speaking, the longer the mortgage term, the higher the mortgage rate for fixed-rate mortgages.
The Bottom Line
These are just some of the factors that influence mortgage rates. Are you interested in learning about more of them? Speak to our mortgage experts today. Our experts are happy to help shed some light.