The Paradox of Fixed Costs: Cheap Homes, High Borrowing Costs

Like any business, mortgage lenders face a combination of fixed costs and variable costs for each loan they originate. Fixed costs are stable regardless of the size of the loan being originated, while variable costs are proportionate to the size of the loan.

Because of these different costs, borrowers seeking smaller loans generally pay more in fees per dollar borrowed than borrowers seeking larger loans, although the total costs associated with a smaller loan may still be less than the overall costs associated with larger loans. Additionally, lenders may be less willing to originate small loans because of their higher costs, and borrowers seeking small loans often don’t have as many options.

Zillow analyzed data on inquiries for 30-year, fixed-rate purchase mortgages and quotes from lenders on Zillow during Q1 2015, controlling for a range of relevant borrower characteristics including credit score and loan-to-value ratios. We found that smaller loan amounts are associated with larger costs and fees (as captured by the spread between the interest rate and the annual percentage rate), higher base interest rates and fewer quotes from mortgage lenders.[1]

The spread between the interest rate and the APR falls as loan amounts increase, although at a decelerating rate. This results in a spread difference that is much larger when moving from, say, a $50,000 loan to a $100,000 loan, than when moving from a $100,000 loan to a $400,000 loan. For example, the average spread between the interest rate and APR was 24 basis points for a $50,000 loan in Q1 2015, compared to 11 basis points for $100,000 loans, and 4 basis points for $400,000 loans.

Given the wide geographic disparity of home values nationwide, this indicates that homes in cheaper communities are more expensive to finance per dollar borrowed. For example, 29 percent of homes in the Detroit metro area, 14 percent of Pittsburgh-area homes and 14 percent of Cleveland-area homes could be purchased with a $50,000 loan. At the other end of the spectrum, almost no homes in big, coastal metros like Los Angeles, San Francisco, New York and Seattle could be purchased with a $50,000 loan (table 1).

	Percent of Homes Able to be Purchased with the Following Loan Amount and 20% Down Payment
n Metro Area n	Less Than $50K	Less Than $100K
New York/Northern NJ	0.1%	1.3%
Los Angeles, CA	0.0%	0.0%
Chicago, IL	2.5%	19.8%
Dallas-Fort Worth, TX	5.7%	30.9%
Philadelphia, PA	1.3%	12.2%
Houston, TX	1.1%	29.1%
Washington, DC	0.0%	1.1%
Miami-Fort Lauderdale, FL	0.4%	8.7%
Atlanta, GA	7.5%	33.5%
Boston, MA	0.6%	1.5%
San Francisco, CA	0.0%	0.0%
Detroit, MI	28.7%	51.8%
Riverside, CA	1.1%	9.5%
Phoenix, AZ	1.6%	14.5%
Seattle, WA	0.0%	2.2%
Minneapolis-St Paul, MN	0.0%	4.7%
San Diego, CA	0.0%	0.0%
St. Louis, MO	13.7%	42.4%
Tampa, FL	10.3%	34.2%
Baltimore, MD	4.9%	14.8%
Denver, CO	0.0%	1.9%
Pittsburgh, PA	14.4%	47.8%
Portland, OR	0.0%	1.5%
Sacramento, CA	0.0%	1.6%
San Antonio, TX	7.0%	39.7%
Orlando, FL	3.5%	21.9%
Cincinnati, OH	6.7%	38.9%
Cleveland, OH	14.0%	47.2%
Kansas City, MO	13.9%	40.9%
Las Vegas, NV	0.4%	11.6%
San Jose, CA	0.0%	0.0%
Columbus, OH	8.4%	35.1%
Charlotte, NC	4.8%	30.9%
Indianapolis, IN	11.0%	40.5%
Austin, TX	0.0%	10.7%

[1] We include only loans that meet the underwriting guidelines for GSE insurance, known as conforming loans.