When you apply for a mortgage loan or refinance, the lender will consider a number of factors when evaluating your situation. One of the key factors is the loan to value ratio.
Loan to value ratio is a ratio of the value of your property against the mortgage amount. To calculate this yourself divide the amount of your mortgage by the appraised value of your home. For example, if your home is valued at $150,000 and your mortgage was 120,000 then your loan to value ration is 80 percent.
When your mortgage lender evaluates your creditworthiness they are trying to assess your risk as a borrower. The larger your loan to value ratio for the mortgage you are requesting the higher your interest rate will be. This is why making a down payment reduces your interest rate.
The sweet spot for loan to value ratios is 80%. If you have a minimum of 20% for your down payment you will be less of a risk for your mortgage lender. A sizeable down payment shows the lender you are responsible with your savings and therefore less of a risk. This reasoning also holds true for paying points. Pre-paying points will lower your interest rate and show you are less of a credit risk.
If your down payment is less than 20% your can improve your credit picture by lowering your debt-to-income ratio. Do this by paying down the balances on your credit cards and closing accounts you are not using or do not need. You can expect your interest rate to be higher in this case; however, by shopping around from a variety of mortgage lenders and doing your homework you may find a loan where your lack of down payment makes little difference.
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