How Your
Credit Score Effects Your Mortgage
by Ellise Walsh
Each year thousands of prospective homeowners are shocked
to discover their credit history will keep them from their dream of home
ownership. While it may seem surprising that an individual could know so
little about their own credit score, the truth is that far too many consumers
go blithely through life, unconcerned about how their financial actions may
effect their future plans. While consumers may be aware there are a few spots
on their credit score, they do not realize the full impact their actions have
and the adverse effects until they are denied a loan. If asked what they
thought their credit score to be, consumers generally respond they believe
their credit score to be fair or good. In reality those same consumers have
absolutely no idea what their credit score is because they have not taken the
time to run a credit check or to research the qualifications for having an
excellent, good, fair or poor credit rating.
While each credit reporting bureau has their own
standards and formulas that they use for the purpose of calculating a
consumer’s credit score, below is a generalized breakdown of what it takes to
hit each benchmark on a credit report:
Excellent credit rating-No late payments, no
collection notices, no bankruptcies or repossessions.
Good credit rating-May contain a late payment within the last two
years.
Fair credit rating-More than one late payment. May or may not have a
bankruptcy or repossession in the last two to three years.
Poor credit rating-Recent collection attempts, late payments within
the last year, bankruptcies and/or repossessions within the last two to
three years.
The effect each credit rating can have on a consumer’s
life is the difference between being approved for loans and being denied. Even
when a consumer is approved for a loan, if their credit is less than
excellent, they will find themselves paying far more interest than a consumer
with outstanding credit. This is because lenders base the interest rates
offered to consumers on the basis of how much risk the borrower presents.
Since individuals with less than perfect credit traditionally present more of
a risk of defaulting on a loan, lenders are able to justify charging more
interest to those consumers. The extra interest the lender earns on the loan
is intended to compensate the lending agency in the event the consumer
defaults on the loan. Over the course of a 15 or 30 year mortgage, those extra
interest points can add up to an astounding amount of money.
But, wait a minute, you might be thinking. If I default
on the loan, the lender can take back the property, sell it and still recoup
their money. While technically, this is true; this will only occur after the
lender has spent significant out of pocket expense in trying to collect money
due from the borrower as well as whatever various legal fees may be involved
in forcing a repossession. The interest money helps to alleviate the out of
pocket expenses paid by lenders who have to force collection and repossession.
Besides higher interest rates, consumers with splotchy
credit may find that banks are not willing to finance as much of a purchase as
they would be if the consumer had better credit. Again, this relates to the
subject of risk. A lender would rather reduce their risk by having the
borrower fund a larger percentage of the purchase. Banks that might would
otherwise finance almost 100% of a home purchase will suddenly drop their
offer to 80% or 90% when a credit check reveals a poor credit rating. In order
to purchase the home, the consumer will need to come up with the remaining
funds out of pocket and that means a considerably larger down payment.
Unfortunately, in some circumstances the extra money required on the down
payment prevents consumers who are already strapped for cash from being able
to buy a home.
The best course of action a consumer can take to fight
negative impacts by their credit score is to be constantly vigilant. Pay bills
on time, monitor your debt load constantly and don’t shift money around from
one account to another. Make a habit of saving all receipts in case a dispute
arises and ends up on your credit report. A consumer’s financial health should
receive a yearly checkup. Staying on top of your credit history by running a
credit check once a year will help you to discover problems while they are
fixable; and not when you’re sitting in front of the loan office.
