How your loan size affects your mortgage rate (and what to do about it)

Why your loan size affects your mortgage rate

Did you know that three families in the same town, with identical credit scores, looking for 30-year fixed home loans will almost certainly pay different interest rates? That’s because there are so many factors that go into your mortgage rate quote.

One of those factors is the size of your loan.

Why size matters in mortgage financing

Loan size matters because of two considerations. The first is that processing a mortgage involves costs, and most of those costs don’t go down just because the loan amount is low. The second is that very large loans can be riskier to lenders.

Low loan amounts

Low loan amount surcharges catch many borrowers off-guard. They can be if it costs $1,000 to process, underwrite and fund a home loan, and the profit on a $400,000 mortgage is $2,000, the lender makes money if it gets a .5 point origination charge.

But if the loan is just $40,000? That .5 point origination fee is only $200, which means the lender would lose $800 by funding that loan. So either lenders stop making smaller loans, or they have to charge more to cover their costs.

So in this case, there might be a “low loan amount” add-on of three more points. The total origination would be $1,400, allowing the lender to cover its costs and earn $400 on the loan.

Covering low loan amount charges

On its face, 3.5 points seems like a huge charge. But remember, for a $40,000 mortgage, that’s only $1,400. But you don’t even have to come up with that.

Your lender can cover the extra fees by taking your mortgage rate a little higher. For instance, three points can be covered with a .5 to .75 percent addition to the interest rate.

Your principal and interest with a $40,000 loan at 4.o percent would be $191. At 4.625 percent, it’s just $15 more ($206 a month). Unlikely to break your bank.

Going big with jumbo and super-jumbo loans

On the other end of the spectrum lie jumbo and super-jumbo mortgages. Jumbo loans are those that exceed the conforming loan limits established by Freddie Mac and Fannie Mae, and super-jumbo loan amounts can run into the millions.

Interest rates for these economy-sized mortgages are often higher than those of conforming loans for three reasons:

• Conforming loans, by definition, conform to guidelines that make them easy to sell. That liquidity keeps lender costs down. On the other hand, jumbo loans are harder to sell, which increases lender costs, and that extra gets passed on to borrowers.
• Jumbo mortgages are less available, and markets are pretty fragmented. That makes them harder to shop for and compare. Jumbo mortgage rates vary among lenders more than conforming rates do.
• Jumbo mortgages can be riskier because of their larger amounts. If a $100,000 mortgage goes sideways, lenders may take a loss. But that’s nothing like the potential losses from $2 million home loan.

These extra-large loans often have stricter underwriting guidelines. For a $4 million home, for instance, you may have to put $2 million down and have a credit score of at least 740.

What are today’s mortgage rates?

Current mortgage rates are among the lowest on record, still. But when shopping for an extra large mortgage, be aware that small differences in the rate can mean big differences in your payment. For instance, a $100,000 mortgage at 4.25 percent has a principal and interest payment of $492. At 3.75 percent, the borrower would save $29 a month and pay $463.

But if you have a $1 million mortgage, that same difference in mortgage rate makes a $290 a month difference in the payment. So the higher your mortgage amount, the more aggressively you should probably shop.