Why do lenders offer different mortgage rates to the same borrower?

Reader question: “I have been shopping around for a loan over the last couple of weeks, talking to different lenders in person and via the web. So far, I have been offered a wide range of mortgage rates, terms and fees. It’s all over the place. But my qualifications haven’t changed. This seems odd to me. Why do lenders offer different mortgage rates to the same borrower? Do they have different ‘ranking’ models or something?”

That’s actually a really good question, and one that doesn’t get asked very often. Let me start by explaining why lenders offer different rates to different borrowers. Everything will make more sense if we start there. Then we can talk about why they might present different offers to the same borrower, which seems to have been the case for you.

Different Mortgage Rates for Different Borrowers

Not everybody qualifies for the same mortgage rates. If you think about the times you have applied for a loan, you’ll remember that the interest rate the lender gave you was partly determined by your credit score, your debt to income ratio, and the amount of money you were planning to put down on the loan. These are some of the strongest factors that influence rates (though they’re not the only ones).

So while home buyer John might qualify for a mortgage rate of 5% based on his credit score and other risk factors, home buyer Jane may only qualify for a rate of 6.25%. The offers you receive will be based on various factors, in addition to your credit score.

Much of it has to do with risk. Lenders typically use risk-based pricing models when assigning interest rates. Simply put, this means they charge more interest for riskier borrowers (those with bad credit, high debt ratios, etc.). Low-risk borrowers, on the other hand, typically pay less over time by securing a lower rate.

So that’s why lenders offer different mortgage rates to different borrowers. Let’s move on to talk about your particular situation, where you are getting different offers based on the SAME set of qualifications.

Lenders have different methods and models for assessing risk, and for pricing loans based on the perceived risk the borrower brings. One company might look at your financial situation and view you as an extremely low-risk borrower, with a very low probability of default. Another company might see that you have a great credit score, but have an issue with the amount of debt you carry in relation to your income. A third lender might put more emphasis on down payments, reserving their best mortgage rates for borrowers who put down 20%. And so on.

The Type of Loan Also Makes a Difference

It’s also worth noting that lenders typically charge higher rates for longer-term mortgage products. That’s why the average rate for a 30-year fixed home loan is generally higher than the 15-year loan (and much higher than they 5-year ARM).

Here’s another variable to consider. The interest rate isn’t the only thing that affects the total cost of the loan. You also need to look at the fees being charged. Yes, mortgage lenders offer different rates based on their pricing models. But they also offer different fees. You can’t just compare one loan to another based on the rate. You also have to consider the full cost of the loan, including all estimated fees, and how that affects (A) your monthly payments and (B) the total amount paid over time.

This is why it’s better to compare home loans by using the APR, and not the interest rate alone. You have to compare apples to apples, so to speak.

So that’s why lenders offer different mortgage rates. It has to do with the type of loan, as well as the level of risk the borrower brings.