A customer looking for a mortgage may ask why a mortgage rate decreases when one increases their down payment. The simple answer is risk. Here is a more detailed explanation on said risk:
In a hypothetical situation, I compared a 200,000 euro face value mortgage over a three year period. I then changed the value of the loan the bank lended to see how that would affect the rate one was given.
When the value of the loan was 150,000 euro (and the deposit was 50,000 euro), the interest rates were typically lower than when the value of the loan was 180,000 euro (and the deposit was 20,000 euro).
The reason the interest rates increase is because the loan to value (LTV) ratio decreased. For example, the LTV of the180,000 loan would be 90% (180,000/200,000). The LTV of the 150,000 loan would be 75% (150,000/200,000).
Bigger deposits should yield smaller interest rates. Why? Suppose the banks had to foreclose the 200,000 euro house because the economy goes bad. If they can hypothetically sell the house for 170,000, they would have -10,000 euro in equity with the 90% LTV (180,000 Loan) mortgage and +20,000 (150,000 loan) in equity with the 75% LTV ratio. The more the banks deposit, the less risk the banks have to deal with in the case that they foreclose.
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