Two big reasons lenders prefer larger mortgages are:
Dollar amount of Equity
For your typical lender, foreclosure is a worst case scenario and one where the lender could end up losing money if their borrower is overleveraged. That’s why the Loan to Value ratio is so important. In the event of a foreclosure, the lower the LTV ratio the more comfortable a lender is that they will be made whole. If a borrower has enough equity in the property they are much more likely to either refinance with another lender or sell the property to make the current lender whole. Makes sense, right? The problem with smaller loans is that even at low LTV ratio levels (40-60%) there just isn’t a lot of equity in terms of actual dollars to make a lender comfortable. Here’s an example:
Scenario 1: LTV Ratio is 50%, property is worth $500,000, total equity in the property is $250,000
Scenario 2: LTV Ratio is 50%, property is worth $50,000, total equity in the property is $25,000
In Scenario 1 a lender feels very comfortable with their loan amount. Even if they have to go through the entire foreclosure process and take the property in, there is plenty of equity to cover property taxes, insurance, legal fees, etc. that they should be able to sell the property and make themselves whole. In Scenario 2, however, the lender does not feel very comfortable. Foreclosures can take anywhere from 6 months to 4-5 years. If it takes 4-5 years, between the property taxes, property insurance, legal fees, etc. that $25,000 in equity disappears very quickly and the lender can be left with an asset worth less than what they dispersed.
Dollar amount of Return
Every single loan a lender looks at requires a certain amount of due diligence before they are comfortable with the loan. For this reason, it’s far more costly to a lender to make ten loans of $100,000 than it is to make one $1,000,000 loan even with the same interest rate on each loan. Let’s say, for example, that every hour spent working on a loan costs the lender $100 and the average amount of time from start to completion of a loan deal 20 hours, which is an average cost of $2,000 per loan. If a lender were to make ten $100,000 loans, the cost to the lender is $20,000. Even if one $1,000,000 loan requires some extra work, say 30 hours instead of the typical 20 hours, that’s a cost of $3,000 for the same return they get from ten $100,000 loans that costs them $20,000.
That’s another big reason why lenders prefer larger deals as it maxims their return on their investment.
While it may not seem apparent at first, the reasons for larger loans being easier to obtain than smaller loans are pretty straightforward. Common sense can tell you that lenders want bigger returns and less risk. Larger loans generally offer both, which is why lenders prefer them over smaller loans.
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