When a Good Credit Score Isn't Enough

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If you're in the market to buy a home, you probably know the importance of having a good credit score. What you may not realize, however, is that as of April 2009, the definition of a "good credit score" has changed dramatically.
"Today's 740 is yesterday's 700," says Todd Huettner, finance and real estate expert and president of Huettner Capital based in Denver, CO. "Great credit scores no longer ensure you get the

If you're in the market to buy a home, you probably know the importance of having a good credit score. What you may not realize, however, is that as of April 2009, the definition of a "good credit score" has changed dramatically.

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"Today's 740 is yesterday's 700," says Todd Huettner, finance and real estate expert and president of Huettner Capital based in Denver, CO. "Great credit scores no longer ensure you get the best mortgage rate."

In fact, says Huettner, your credit score can make or break you. "Lenders raised the bar with tighter lending standards, and now the cost of each home loan is based on credit score. Previously, credit scores had to meet a minimum requirement, but did not affect the rate or cost of most loans."

Lenders are also taking the down payment amount into consideration. "Under these revised rules, borrowers who believed their credit scores were solid enough to earn them lower rates will be paying more fees if they can't come up with a down payment of at least 30 percent," explains Raymond Brown, president and CEO of World Transactions Group, Inc., the leading reseller of bank-owned and discounted properties (also known as REOs).

Mortgage companies expect you to save up and put down a significant amount of cash before they'll lend you the rest. As a show of good faith, borrowers are expected to come to the table with a significant amount of cash in the form of a down payment. "Gone are the days when you could buy a home despite your credit, with nothing down," affirms Avi Karnani, co-founder of JustThrive.com, a free online personal budgeting service.

"Down payment requirements will keep rising. People may elect to pay fewer points (prepaid mortgage fees) up front and instead have them factored into the monthly mortgage payment since more of their money will be going to the down payment."
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Borrowers whose credit scores are less than stellar or who are able to make only a small down payment will pay fees to the lender. "You always have a choice with the fee," says Carolyn Warren, author of Home Buyer Beware: Who's Ripping You Off Now? -- What You Must Know About the New Rules of Mortgage. "You can pay it as a fee in the closing costs or take a higher interest rate instead. Or you can compromise by paying some of the fee and taking a little higher rate. The compromise option is common."

Jeremiah M. Wean, partner for Lakewood Lending Group, LLC, tells borrowers, "If your credit score is under 700, you will not be able to obtain the elusive low rates without paying substantially to get them." High-risk borrowers -- those with credit scores below 720 and small down payments -- will pay penalties called Loan Level Price Adjustments (LLPAs).

"The LLPAs are added to the overall cost of the loan," explains Bill Berliner, capital markets consultant and co-author of Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques. "Unless the lender adjusts the interest rate to reflect the required LLPAs, they are paid as part of the closing costs."

Tightening the belt

Fannie Mae and Freddie Mac are the federal mortgage associations driving these drastic changes. "Just like life insurance companies that base their pricing on how old you are or auto insurance companies on how safe a driver you are, these agencies make your mortgage cheaper or more expensive based on how risky your financial situation is," explains Karnani.

Since Fannie Mae and Freddie Mac guarantee lenders timely payment, these institutions also set guidelines for the loans they will accept.

"You might say it's a bit like Las Vegas," adds Warren. "If the lender thinks you're a greater gamble for the money, they will want better odds to take a chance on lending you money. Therefore, you pay more."

Risk-based guidelines

Although the new risk-based pricing guidelines did not take effect until April 1, 2009, interest rates adjusted quickly and banks increased rates in anticipation of the changes. In addition, mortgage insurance companies increased their underwriting criteria, not allowing more than a 95 percent loan-to-value ratio on home purchase loans. The loan-to-value (LTV) ratio is the amount of the mortgage expressed as a percentage of the property's assessed value. Because of these new underwriting requirements, borrowers must come up with more cash at closing.

According to Wayne Sanford, New Start Financial Corporation, Fannie Mae is implementing an "adverse market delivery charge" and Freddie Mac is calling its fee a "market condition delivery charge.

For loans under $417,000 (conforming loans), buyers with less than 10% down payment and a credit score between 720 - 850 can expect to pay at least .25% of the loan amount. Borrowers with a credit score from 719 to below 620 can expect to pay anywhere from .50% to 2% of the loan amount. Lenders may choose to waive the fees for higher interest rates on the loan. Each point in fees is equal to a quarter point of interest rate (a 4-to-1 ratio).

A truly good credit score

So what is a solid credit (or FICO) score? The aggressive new FICO classifications are as follows:

-- 740 - 850: Excellent borrowers qualify for the best financing terms.

-- 700 - 739: Very good borrowers receive favorable financing.

-- 660 - 699: Good borrowers should qualify for most loans.

-- 620 - 659: Fair borrowers may qualify but will pay higher interest.

-- Below 620: Poor borrowers will likely not qualify for a loan.

"If you are a borrower looking to buy a home with what used to be considered 'good' credit (i.e. a credit score in the lower 700s) and want to put down less than 30 percent of the home's value," elaborates Berliner, "then your loan will be more expensive than the quoted rates." Simply stated, quoted rates are only applicable to excellent borrowers with a lot of cash on hand.

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