The Veridian Blog

The interest rates we hear on the radio or see on the newspapers are often misleading because they don't apply to every consumer.  Rates are not a commodity like apples that you buy at the grocery - they have the potential to be different for every applicant and every loan scenario.  Here are some factors that may influence the Note rate on any given application:

1. How much the borrower pays out of pocket.  Whether the label is “points”, “origination fees”, “closing costs”, it is all money out of the borrower’s pocket.  And the more money that they put forth, the better interest rate they can obtain by buying down the loan.  The lender will happily offer better rates over time because of the cash they are receiving here and now.  All the other factors below deal with the lender’s risk.

2. Loan program – The riskier the program, the better the rate for the borrower (under normal economic conditions).  Thus, a 5/1 adjustable rate mortgage will yield a better interest rate because over time, the lender will likely receive more income when rates increase.  At least, that was the theory before the mortgage world imploded…  The 5/1 ARM is currently as popular as ever, but the extreme exotic programs like Pay-Option ARMs are nothing but a distant memory.

3. FICO score.  The higher the credit, the less the chance of default and hence lenders offer their best rates to the most creditworthy customers.

4. Loan to Value ratio (LTV).  The higher the borrower’s equity (the lower the LTV), the less the chance of default and hence the lenders offer their best rates to the customers with the most asset ownership at stake.

5. Debt to Income ratio (DTI).  The lower the DTI, the less the chance of default and hence lenders offer their best rates to customers who have the highest ability to repay.

6. Lock period.  The shorter the rate-lock period, the less risk the lender is exposed to market fluctuations and hence offer their best rates.

7. Loan Purpose.  Purchase loans yield the best rates, followed by “rate & term” refinances, and lastly “cash-out” refinances.  Studies have shown that defaults are most likely to occur after cash-out refinances.

8. Occupancy.  Borrowers are less likely to default on their primary residence versus second/vacation homes and especially rental/investment properties.

9. Property Type – It’s riskier for the lender to hold collateral that is in a tall building (high-rise condo), or is subject to HOA rules and regulations (condo’s, townhouses and PUDs), or is an attached home. 

10. Amortization – Borrowers are less likely to default on fully-amortized principal & interest loans as opposed to interest-only and negative amortization loans.

11. Impounds – Lenders offer borrowers the chance to pay their taxes and insurance on a monthly basis instead of having to make lump sum payments once or twice a year.  The service is complimentary of course – after all, they are quite happy to take your money months before having to pay it on your behalf.

12. Documentation level– Not so much a factor anymore, simply because there aren’t more than 2 or 3 different doc levels anymore and those with less-than full documentation really pay up the nose in terms of higher interest rates.  The less documentation a borrower is willing to disclose, the higher the risk of default to the lender and as a result, they charge a higher interest rate to compensate for that risk.