A credit rating determines how much it will cost people to borrow money. Lenders use this rating to determine their risk. Banks discovered people with higher scores almost always repay loans while individual with lower scores may not be able to make payments as agreed. Since a credit score is a number, even a few points influence the cost of borrowing money. Although credit rating affects down payment requirements, this article will focus just on the monthly payments and the real cash rewards or consequences.
A credit score is a numeric calculation based on the credit rating and ranges from 350 to 850. Banks and other finance companies charge interest based on the amount of risk they believe they are taking. One way lenders determine who is safer and who poses a bigger risk is to review each person’s credit score. To qualify for a home loan, borrower needs a score of 500 or more. Most lenders require scores of 620 or above to approve a home loan with the best interest rates reserved for individuals with scoring over 700.
What This Means
Life is less expensive for people who have high credit scores. This rating process forecasts what people will do in the future based on how they handled their bills in the past. Individuals who mastered budgeting and paying bills on time are rewarded while people who struggle to pay their obligations are penalized with higher interest rates.
Cold, Hard Figures
The easiest way to understand this procedure is to compare the financing of three homebuyers purchasing a $200,000 house on a 30 year fixed interest mortgage. A homebuyer with the FICO score between 760 and 850 might be able to finance a home with a 3.581 annual percentage rate of interest (according to recent rates and figures, subject to change). These payments are $907 a month and the total interest over the 30 year loan is only $126,576. If the person had a FICO score between 620 and 639, a 5.17 annual percentage rate of interest is charged. That interest rate raises the payment to $1095 a month with total interest costs of $194,027 for 30 years. In this example, consumers who pay their bills on time and manage credit wisely have an extra $188 a month to spend on whether they want. Over 30 years, credit wise people save $67,451 in just interest. (Once agin, these figures are only hypothetical and based on recent figures and calculations. Please always consult with your own mortgage lender.)
These differences can be even more startling when a mortgage rate increases to 6%. The same homebuyer faces a monthly payment of $1199. Over 30 years, this individual may need to repay the lender a total of $431,640 which includes interest payments of $231,640.
Lenders use a credit rating to determine the ability of a borrower to repay a home loan. Because people with high scores are more likely to pay back the money, banks and other finance companies charge less interest on these loans. However, people who have had problems repaying obligations in the past may not be able to make their monthly payments on time or at all. Therefore, these people pay a higher mortgage rate to get the money they need.