Are you working towards financing a home? You probably know how your credit rating will impact your loan qualification. You pretty much need the minimum credit rating for FHA home loans, which is a 580 FICO score. If you cannot qualify for FHA insurance, you will be hard-pressed to find any lender until you fix your credit.
There are many implications that your credit rating can have on your prospective home loan, such as whether you actually qualify for the mortgage, how low of an interest rate you will get and what type of lender will work with you.
Now, there’s also an unspoken factor: how much your mortgage will cost in total.
How Your Mortgage Could Cost More
When you apply for home financing with a bad credit score, it is unlikely that a major bank will approve you. Since it is the major banks that get the best borrowing rates in the first place, your alternatives will be more costly. In the worst case scenario, only a private lender would consider you.
You might be somewhere in the middle and can get a home loan through a financial institution that accommodates bad credit borrowers. There are many reputable lenders in this area, but you still face the issue of a higher interest rate. This is because the banks know you are a higher risk.
Tip: Get your mortgage through a highly legitimate financial institute that works with bad credit borrowers while also offering traditional home loans. That way, you can repair your credit while holding the costlier loan and refinance under the same lender after your credit score improves.
Your credit score does not have to hold you back from a mortgage. You just need to make sure it’s not unexpectedly costing you extra.
What Will Your Credit Score Cost You?
When applying for a home loan, your decided interest rate is mainly calculated based on your credit score. So if you were to apply for a mortgage right now, what would this mean to you?
It all depends on where you live …
Let’s use Manhattan, New York as an example, seeing as how even a one-bedroom will easily set you back $400,000 or more.
Say you are buying an apartment for $400,000 and you give the minimum of 10 percent down. This leaves you with a $360,000 principal to finance through a mortgage provider. Let’s say the mortgage will run for 30 years and it’s a fixed-rate loan.
Below shows your total interest cost for the lifetime of the mortgage. These calculations come from MyFICO.com’s Loan Savings Calculator, which estimates your interest rate based on your FICO score range.
- 620 to 639 FICO score: $319,418 total interest (4.793% APR)
- 640 to 659 FICO score: $277,706 total interest (4.252% APR)
- 660 to 679 FICO score: $245,727 total interest (3.825% APR)
- 680 to 699 FICO score: $230,167 total interest (3.613% APR)
- 700 to 759 FICO score: $217,414 total interest (3.437% APR)
- 760 to 850 FICO score: $201,683 total interest (3.217% APR)
To put it into context, you are looking at saving $117,735 over 30 years by financing with perfect credit instead of below-average credit. From another perspective: your monthly payment will be about $327 less!
How to Make Your Mortgage Cost Less
There are some tricks that can help you qualify for a more affordable mortgage. Four simple ways to do this include:
1. Refinance Your Mortgage After You Buy
Your mortgage payments go through on time for half a decade, and suddenly the huge debt does not keep your credit score suppressed. The result could be seeing your credit rating go up by a considerable amount since when you first qualified for the mortgage. If this is the case, you could refinance the mortgage to lower your interest rate and ultimately make the rest of the mortgage term cheaper for you.
2. Rent-to-Own the Place First
If you are repairing your credit, but you want your new home now, you could try to buy through a rent-to-own agreement. You will be able to guarantee the seller gets the asking price as long as you follow through with financing at the end of the term. While the rent-to-own contract will set you back a little in equity, the much lower interest rate will create much more savings.
3. Wait a Little Before Buying
While this is not the most exciting solution, sometimes it makes a lot of sense. Say you have a bad debt in collections from six years ago. If that’s the case, waiting roughly a year will cause the negative item to leave your credit report and thus it will not hold back your FICO score. The end result could be a huge boost in your credit rating, or at least enough to score you a better interest rate.
4. Purchase Under Owner Financing
If you want your new home now, but rent-to-own will not work, you might be able to purchase via owner financing. This means the seller holds the mortgage for you for so long (usually 1 to 3 years), and then you can get your mortgage and make a balloon payment to buy it out. You can use the in-between time to repair your credit and this will help you secure a good interest rate. In the meantime, you will be paying on the home under the current mortgage conditions and your bad credit status will not cost you more.
Owner financing is really the only cost-effective and sound way to approach buying a home with bad credit. Otherwise, you could be throwing well over $100,000 out the window. That’s a lot of extra money to pay, especially if you are actually eyeing a one-bedroom apartment.
To conclude, get your credit repaired before applying for a mortgage because the cost of doing so is minuscule in comparison to what you will save on interest payments.
Sources:
- http://www.fha.com/fha_credit_requirements
- http://www.myfico.com/crediteducation/calculators/loanrates.aspx
- http://www.investopedia.com/articles/mortgages-real-estate/10/should-you-use-seller-financing.asp
