Did you calculate the cost and find out your mortgage payments will be high? If so, your credit score could be to blame.
Buying a Home With Average Credit
You need a FICO score of 620 or more to be taken seriously by most traditional lenders. With FHA financing a score of 580 or more is needed, but FHA loans come with other requirements.
The thing is, you don’t want to just have a “good” credit score. There’s a big difference when you’re buying a house. It’s too big of a loan to approach when you’re not an optimal borrower.
The Difference in Monthly Payment Costs
The biggest comparison to make is a $200,000 loan over 30 years. With a FICO score of 620 to 639, you’re looking at a 4.79 percent APR rate. This comes with a $1,048 monthly payment. A borrower with a FICO score between 700 and 759 will pay $890 a month.
As a result, improving your FICO score before financing a $200,000 mortgage can save you $150 a month. There are other poor terms that come with a low-grade home loan. You might effectively lose as much as $250 a month as a result of not qualifying for a better mortgage.
The Cost of Buying a Home by FICO Score
It’s common knowledge that your credit rating affects your interest rate. However, not many realize how much of an impact it will have on the overall cost of your new home. So it’s interesting to see what you can expect to spend when buying a home — based on your FICO score.
Take a look below for a rough run-down with an analysis for a home buyer with a FICO score in the 620 to 659 range. This information comes from the Loan Savings Calculator on myFICO’s website.
Interest Cost Differences
In this score range, you can expect an APR between 4.244 and 4.79 percent. Say you’re borrowing $80,000 toward a home and you plan to pay it off in 15 years.
This averages out to between $574 and $596 a month for mortgage premiums. It also means $23,340 to $27,253 in total interest paid over the 15-year term.
How Much Can You Save on a $200,000 Mortgage Loan?
This scenario gets even more interesting when you look at the purchase of a $200,000 home loan. Borrowing that amount requires having a sizable down payment or income.
This loan will cost a lot more if you take it on while you have only average credit. You might find yourself opting for a 30-year term to avoid the high monthly payments. In this case, the interest difference can “blow your mind” when you discover it.
A low 600s credit rating would mean approximately $150,000 to $175,000 in interest paid over 30 years on a $200,000 loan.
Borrowers with FICO scores in the low 700s can expect to receive $40,000 to $60,000 in interest savings.
Other Benefits of a Better FICO Score
With a strong FICO score, you can bully around lenders. When buying a home, this means you have the power to negotiate the best APR rate possible.
This means you can save a lot on your interest payments. This results in a lower monthly payment too. You could save as much as a few hundred dollars a month.
Being able to pick and choose between lenders is a good thing for other reasons, too. You can gain access to terms like “early buyouts without penalties,” which is hard to find.
This is especially beneficial if you inherit a lot of money or win the lottery. The loan term will make it so you can pay off your last month of interest and buy out the rest of the loan.
Don’t Forget About the Refinancing Dilemma
Next, you need a strong FICO score to qualify to refinance your mortgage. Having the bare minimum is not good enough if the borrowing requirements change over time.
It’s also not helpful if you end up with another blemish that pushes your score below the minimum. When your loan term is up, you might find yourself selling the house or foreclosing if your credit score is low.
The same is true if you’re using a co-signer to qualify for the mortgage. If this person cannot qualify anymore, you might not be able to pull the weight when you attempt to refinance. Since you only gain considerable equity in the later years (due to more interest paid upfront) this is a serious disadvantage.
Remember What Happens Next
When you first take on a new loan, your credit score drops before it ages a bit. The negative effects of the new debt become less month by month. In the end, your good repayment history and strong utilization rate will result in a higher FICO score.
However, in the near term your credit rating will suffer. The large home loan will make you seem like a bad borrower. So you might struggle in financing for even smaller things (like store cards) in the first six months after you finance your home.
If you take in anything from reading this, it should be the fact that a better FICO score means a better loan. This is true whether you’re buying a car or a house. It’s even true when you’re trying to take out a second mortgage.
We went as far as to cover a piece listing four reasons your credit score matters during retirement. You can read that blog post and find even more reasons why you’ll want to build your score before it’s too late.