Small mortgage loans might seem like a myth, but there might come a time in your life when you want to get a mortgage for a small amount, such as to refinance your current, barely there loan to take advantage of a lower rate. While some lenders won’t touch a small home loan, you aren’t necessarily out of luck when it comes to getting one.
Less money for the lender
Mortgage lenders are in the business of making money. The smaller the amount you borrow, the less money they make in the long run. For example, if you pay 4 percent interest on a $50,000 home loan for 30 years, you’ll end up paying more than $35,000 in interest. But if the original mortgage amount is $150,000 and you pay 4 percent interest for 30 years, the amount of interest you’ll pay is more than $100,000, a considerably higher amount for the lender.
Along with bringing in less over the long run, small mortgage loans tend to cost the lender more up front and may not even cover their expenses. When you take out a mortgage, a lender charges a loan origination fee, which can be small percentage of the value of the mortgage. If your loan is amount is just $50,000 and the fee is 1 percent, the lender takes home $500. If the fee is a flat amount, such as $5,000, you’ll end up paying more relative to the amount of the mortgage if your home loan is small.
More risk for the lender
Although it might seem that a smaller mortgage amount would be less risky for a lender, in many cases, it tends to be riskier. According to researchers from Carnegie Mellon and the University of Virginia, individuals who have smaller incomes and lower credit scores are often considered to be high-risk borrowers, meaning lenders believe they are more likely to default on their loan. Borrowers with lower income and lower credit scores also tend to take out smaller loan amounts.
The refinancing challenge
A low balance isn’t only a challenge when you’re trying to take out a loan initially. It can also be an issue when it’s time to refinance, after you’ve paid down a considerable amount of the mortgage. In many instances, a lender might be hesitant to let you refinance a low balance, as it won’t make much money off of the deal, especially if you’re refinancing to a lower rate.
But you do have a few options if you hope to refinance. One is to take out a no closing cost loan, which means you avoid paying fees upfront. Instead, the fees are absorbed into the interest rate on the loan, so the lender receives more money over time. Another way to refinance a small loan is to add to the amount of the loan, then pay the extra amount back right away. Talk to your mortgage lender about what will work best for you.
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