Why It Can Be Difficult to Get Small Mortgage Loans
Do you live in an area where homes can be bought for $120,000 or less? If so, lucky you! Relatively inexpensive housing is a tremendous boon for prospective home buyers. Yet borrowers who need a comparatively small mortgage may encounter a challenging reality of the mortgage marketplace: Many lenders won’t originate a first mortgage of less than $80,000.
Lenders shy away from smaller mortgages because they aren’t as profitable as bigger ones. That’s because many of the fees associated with a new mortgage are based on a percentage of the loan amount. For example, assume a lender can earn 1 percent of the loan amount when the loan is originated and 1.5 percent of the loan amount when the loan is sold into the secondary market. That total of 2.5 percent would amount to $7,500 on a $300,000 mortgage, but only $1,250 on a $50,000 mortgage. The smaller sum might not be adequate to pay the lender’s expenses and the salesperson’s commission, much less generate a profit for the lender.
Federal and state laws usually permit lenders to charge much higher fees to originate a mortgage, but many lenders still opt not to offer these so-called "high-cost" mortgages because the regulatory burden is heavy and the penalties for mistakes can be harsh.
Nonetheless, small-balance mortgages are available, though typically at a somewhat higher cost to the borrower. Likely sources include local community banks, credit unions and stock brokerage companies. These institutions may be more willing to originate small-balance mortgages because they keep such mortgages on their own books and earn interest over the years. They may also want to establish a broader relationship with the borrower, who could become a customer for other financial services.
Small-balance mortgages typically don’t entail additional or more onerous credit standards or other qualifications than larger loans do, though lenders may be more sensitive to appraisals and loan-to-value ratios (LTV). That’s because a higher LTV on a less inexpensive home is riskier than a higher LTV on a more expensive home. For example, an additional 5 percent down payment adds $5,000 of equity to a $100,000 home whereas the same 5 percent adds $15,000 of equity to a $300,000 home.
Small-balance mortgages are also tend to be comparable to larger-sized mortgages in other respects. Mortgage rates may be fixed or variable, and loan terms may be 15, 20, 30 or even 40 years. A longer term doesn’t produce as significantly lower a payment on a smaller loan balance, so a shorter term can be smart if you can afford the higher payments.