If you are thinking about taking out a mortgage loan, whether to purchase or refinance, you’re not always necessarily going to get the preferred interest rate if your loan amount is on the lower end. It is certainly a contradictory way of thinking, but it’s true.

The reason is because Fannie Mae and Freddie Mac have what is called “loan level pricing adjustments,” which adjust the mortgage pricing based upon several parameters. These parameters include things such as credit score, debt-to-income ratios, loan program, and loan amount, among others.

If you’re going to do an apples-to-apples comparison on mortgage rates, you need to make sure you’re comparing the true costs.

Why do smaller loans cost more?
It’s simple – it’s profitability for the federal government. Which scenario is going to pay more to an investor? A person paying 4.25 percent on a 30-year fixed-rate mortgage with the loan balance of $300,000 or the same scenario if the loan amount is $100,000?

Obviously, the $300,000 scenario is much more profitable to the bank over time and as a result, they will reward you with a lower priced loan and rate. Yes, most banks and mortgage professionals will not give you this information. For example:

Scenario A
Client has an 800 credit score, 50 percent loan-to-value, fantastic income and assets, and they are electing to pay monthly escrows. Their loan amount is $300,000. There is only one pricing adjustment and that is .25 percent for the better due to a credit score over 740.

Scenario B
Client has an 800 credit score, 50 percent loan-to-value, again strong income and assets, and they are electing to pay taxes and insurance on a monthly basis. However, their loan amount is only $80,000. They have the pricing adjustment of .25 percent for the great credit score as well as another loan amount adjustment in the amount of .375 percent.

This extra premium of .375 percent of the loan amount can easily equate to thousands of extra dollars every year in the lender’s pocket. The homeowner gets the mortgage because they’re unfamiliar with this pricing adjustment. It is the “cost of doing business” with the lower loan amounts.

Pricing on small loans and how it affects their cost

•All other characteristics are considered equal-
•Loans under $100,000 pricing adjustment of .375 percent.
•Loans over 100,000 through $174,000 pricing adjustment of .25 percent.
•Loans $175,000 and over no pricing adjustment based upon loan amount.
So when you’re doing your mortgage shopping and you’re comparing Sonoma County mortgage loans, be aware of these low-level pricing adjustments if your loan amount is under $175,000. The premium for these mortgages has to be paid by someone. These adjustments are in place because Fannie Mae and Freddie Mac simply do not have as big of an appetite for smaller loans as they do for the bigger ones.

Avoid extra loan-level pricing adjustments on smaller loans
Consider your other unsecured debt (i.e. auto loan, credit cards at 7 percent, etc). It may make more sense to cash-out the refinance and pay off those unsecured revolving accounts while fixed-rate money remains favorable. If your minimum loan amount is $175,000, you can avoid the .375 percent loan level adjustment. It’s important to find the lowest and best mortgage rate quotes available. Contact us and we can discuss why small loans can sometimes cost more. Read more: www.sonomacountymortgages.com/2011/10/small-loans-cost-more/#ixzz1cwKooqx7.

Scott Sheldon is an FHA specialist, a local lender who helps with refinancing and purchasing, and a Senior Mortgage Loan Originator with over six years of mortgage experience. He can be reached at (707) 217-4000.