Everyone is aware of the rates that are offered by lenders, however, these are basically the lowest advertised interest rates available to borrowers. Very often, borrowers may feel that they have been lied to when they do not receive the rate that they are hearing or reading about. However, there is definitely a reason for this because there are 3 details that affect the mortgage rate that is offered to a borrower.
1. Debt to income – The debt to income ratio (DTI) is a calculation of the total debt held by a borrower in comparison to the total income. Mortgage products have maximum debt to income ratios that are acceptable. In addition, lenders may add their own restrictions which may further reduce the debt to income that is necessary for a particular mortgage program. Since debt to income measures the total amount of debt that a borrower has and will have with the new mortgage, it is important that as much debt as possible is reduced prior to applying for a mortgage. The higher the DTI, the mortgage rate offered to a borrower will also be higher.
2. Credit Scores – While DTI is an important measurement of debt and income held by a borrower, credit scores are a reflection of that debt and how it is managed. While both scores and credit history are considered when processing a mortgage, the actual middle score will be used when determining the mortgage rate to be offered. Borrowers who have higher credit scores, are offered the lowest rates.
3. Loan to Value – The loan to value (LTV) of a mortgage is the measurement of the loan against the value of the property that is either being purchased or refinanced. It is the final appraisal that determines the loan to value for the lender. While different mortgage programs have varying loan to value rules, such as FHA and VA, conventional mortgages require the lowest loan to value. This means that borrowers must have a larger down payment for this type of mortgage. Any LTV above 80% will require that the borrower pay private mortgage insurance. In addition, with higher loan to values, the mortgage rate will also be higher.
Lenders use rate sheets when quoting a mortgage rate to a borrower. These rate sheets have adjustments for each of these separate occurrences listed above. Each adjustment adds a certain percentage to the initial mortgage rate. For this reason, the final mortgage rate that a borrower is offered and accepts is seldom the same as the advertised rate.