Lender loan Equity Requirments

[Ikenna Okoye]

Hi all,

I've been having a hard time understanding some pretty fundamental knowledge in real estate. I've read some posts about the importance of equity in a property, especially for wholesaling and flips, though my question is this. If an individual sells their property with lets say 5% equity, why does it matter if the property has little or even zero equity if the bank will pay the original lien off and issue a new loan to another borrower for a presumably larger amount? 

I'd really like to understand this from a banks perspective. Also please correct me on any incorrect points I've made. Any input would be greatly appreciated. Thanks.

[Jesse Rivera]

Equity on the seller side doesn't make much of a difference, as long as the buyer's loan can pay it off. What makes a big difference is equity on the buyer's side.

You will find that every loan guideline is about risk to the bank (LTV, FICO score, income, reserves, etc.). The more equity you have when you buy or refinance (loan to value), the better interest rate you have. More equity equals less risk to the bank.

The reason VA is 100%, or FHA is only 3.5% down, is because they are guaranteed (VA) or insured (FHA) by the US government. And any conventional loan with more than 80% loan to value must have mortgage insurance. This means that if the borrower defaults, the lender will still be secure, they will not lose money (and many times make more money). These programs are designed to encourage home ownership and protect lenders at the same time.

Less risk = better interest rate.