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Different Loans Have Different Costs

Sometimes Orion’s brokers are asked by clients, “Why is the cost for a loan with 20 percent down more expensive than a loan with 10 percent down?” Risk mitigation of course. While it is true that a person who puts more money down is less likely to go into foreclosure, the housing crisis showed many families who lost their homes had purchased it with 20 percent down or more.

The cost of foreclosure for any lender is typically greater than 30 percent of the loan amount. The losses to a lender for a loan that originated as an 80 percent mortgage are greater than the losses for a loan originated at 90 percent mortgage.

Wait…what? The math works out if you factor in private mortgage insurance, regardless of interest rate climate. The loss is less for a loan with less down. Remember the purpose of mortgage insurance is to reimburse the lender a certain percentage of the loan amount should it go into foreclosure, typically 65 percent of the original loan balance.

Let’s say Frank and Francine are purchasing homes next door to each other for $400,000. Frank is putting 20 percent down for a $320,000 mortgage and Francine is putting down 10 percent for a $360,000 mortgage. Francine is required to have mortgage insurance that adds to $132 per month to her payment, but it covers the lender for 25 percent of the original mortgage ($90,000).

The cost to a lender or servicer, should Frank be foreclosed on, is about $96,000. Add the cost of the foreclosure to the loan balance and the total is $416,000. Even if the loan balance has decreased and the home value has increased, there is little room for a lender to break even.

Now if Francine goes into foreclosure, the cost to the lender would be about $108,000 but the lender will get a check for $90,000 (from the mortgage insurance) and the lender will lose $18,000. This is if Francine defaults on the first day of the loan and there is no change in property value.

There are of course a variety of factors that could also come into play with the Frank and Francine saga that could change the bigger picture. The bottom line, however, remains the same: the lower the risk, the lower the cost of the loan. Orion offers some loan programs with very low down payments, and our AEs are experts and explaining the pros and cons of them, as well as private mortgage insurance options.

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