But very small loans can also come with higher rates and relatively higher fees than larger loans.
Evidence of this comes from a new study by Zillow, which found that borrowers with $100,000 mortgage loans pay 10% more per dollar borrowed compared to those with $400,000 loans.
Not only are these borrowers subject to higher interest rates and fees, but it’s also more difficult to find a lender.
Using data from loan requests and quotes on Zillow Mortgages, the company determined that the average mortgage rate offered on a $100,000 home loan during the first quarter was 3.95% with an APR of 4.06%.
Meanwhile, the average borrower who submitted a loan request at $400,000 received a more favorable interest rate of 3.64% with an APR of 3.7%.
Additionally, the high-loan amount borrowers received twice as many quotes as the low-loan amount borrowers. That could partially explain why the rates are higher, seeing that there’s less competition.
With fewer competitors, there’s less incentive to lower rates. There’s also less willingness for borrowers to shop around if they feel their options are limited.
Lenders also face difficulty in originating small loans, especially with the points and fees caps associated with the Qualified Mortgage rule.
Put simply, they’re limited in what they can charge without the loan appearing to be high cost.
And borrowers will have a tough time making good use of a lender credit when their loan amount is on the smaller side.
You May Be Charged for a Small Loan Amount
If you look at a lender’s rate sheet, you’ll often see that there are pricing adjustments for small loan amounts.
So if you have a loan amount between say $50,000 and $100,000, you may actually be charged a bit more, which will either lead to a higher interest rate or higher closing costs.
And many lenders won’t offer loan amounts below $50,000, which explains the lack of quotes on Zillow.
After all, if they have to do all the work they’d normally do with a $500,000 loan, why would they want to focus on loans a fraction of the size where profits are capped and minimal, especially when many costs are fixed?
While this might not seem important, Zillow notes that more than a fourth of all U.S. homes would have a mortgage of $100,000 or less if everyone put down at least 20%.
I guess the silver lining in this instance is that most people put down much less than 20%, for better or worse.
At the same time, a difference in rate on a small loan won’t alter the monthly payment much.
For example, a rate of 4% on a $100,000 loan equates to a monthly payment of $477.42. If you were to snag a rate of 3.75% instead, you’d only save about $15 a month. That’s certainly nothing to get worked up about.
However, if a small loan were held to term the interest costs could be more substantial.
Zillow noted that if the $100,000 borrower were offered the same interest rate/APR as the $400,000 borrower, they would save $7,560 over the life of a 30-year fixed-rate loan.
If you’re in need of a very small loan amount, such as $50,000, it could make more sense to look at a home equity loan with limited closing costs. Otherwise the cost of the loan could outweigh any benefits or make them very minimal. There’s also paying with cash, if possible.