One of the biggest factors in mortgage pricing is the relationship between the home’s value or purchase price and the amount you need to borrow. This relationship is called the loan-to-value, or LTV. To calculate an LTV, divide the loan amount by the home value. If you refinance a $200,000 home with a $150,000 mortgage, $150,000 divided by $200,000 is equal to .75, or 75 percent. The higher the LTV, the riskier the loan is for the mortgage lender, and the more it will charge you. More…
How LTV affects mortgage rates, continued…
Fannie Mae and Freddie Mac set loan fees and guidelines for the majority of home loans – 75 percent of home loans in 2011, according to Inside Mortgage Finance. And Fannie Mae and Freddie Mac vary their fees with the size of your down payment or the amount of home equity you have. For example, someone with a 680 FICO score pays 1.25 percent more in mortgage fees if he puts 20 percent down than he would if he put 30 percent down. But now it gets tricky – you’d think that the fees would be much higher if the buyer only put five percent down, but it doesn’t work that way. Here’s how the fees look for a home buyer with a 680 credit score at various LTVs:
It makes sense that the added fees should be higher for an 80 percent mortgage than for a 60 percent home loan, but why are they lower for a 90 percent mortgage? The answer is mortgage insurance. Fannie Mae and Freddie Mac require that you pay for mortgage insurance if you put less than 20 percent down when you buy a home or have less than 20 percent home equity when you refinance. This reduces their risk, so they can charge lower fees. Overall, though, you’re paying more to finance a home with a 95 percent loan than you do to finance with an 80 percent mortgage.
How much does mortgage insurance cost? It depends on your LTV and your credit score. You can pay a single premium or monthly installments (most people choose monthly installments, but we’ll use the single premium here so that the mortgage insurance and loan fees are all expressed as a single, upfront charge).
This graph shows how mortgage insurance single premiums increase with the LTV for a borrower with a 680 credit score:
And finally, we’ll graph both the mortgage insurance plus the LTV surcharges, demonstrating how the upfront costs increase as your LTV increases:
Government loans – FHA, VA and USDA
FHA loans operate differently. FHA mortgages, which allow you to put just 3.5 percent down when you buy a home, require an upfront mortgage insurance premium (MIP) of 1.75 percent, which can be paid at closing or added to your loan. In addition, FHA borrowers pay monthly mortgage insurance premiums – for at least five years no matter how much they put down or how much their home’s value increases.
VA mortgages don’t require mortgage insurance, but they do come with funding fees. The amount of the funding fee depends on the loan’s LTV, the status of the veteran or service member, and if the borrower has ever used his or her eligibility before. It may be paid upfront or added to your loan.
USDA loans allow 100 percent financing in rural areas. They require a two percent funding fee, which can be paid upfront or added into the mortgage. In addition, there is monthly mortgage insurance.
Jumbo or nonconforming mortgages are not government loans, nor do they fall under Fannie Mae or Freddie Mac guidelines. Their rules and their fees are set by the lenders that make the loans and the investors that buy them. One lender’s rate sheet, for example, charges .75 point more in fees (which translates to a rate that’s .125 to .25 percent higher) for an 80 percent mortgage than it does for a 65 percent home loan. And loans over 80 percent are not offered.