The Connection Between Credit Scores and Interest Rates
In July 2009, Catherine Calame, a 44-year-old marketing director from Bayport, NY decided it was an ideal time to refinance. Interest rates were low and she wanted to consolidate her original home loan and a home equity loan, moving them from a 30 year to a 15 year. Calame says her credit score, sitting pretty at 760, played a pivotal role in snagging such a great rate -- 4.5 percent over 15 years. "Even the attorney for the closing was impressed." Having a lot of equity in her home also helped -- it's worth almost four times the amount of the loan.
Calame's recent refi was a slam dunk and she says the impact her high credit score had on her interest rate was indeed deep. She saved more than $150,000 over the course of the loan and while she understands she'll never truly "see" that money, it makes her feel better heading toward retirement. "It was the big payoff that I've been waiting for my whole life, practically," says Calame.
"Your parents always tell you to start a credit line by opening up credit cards and paying your utilities on time ... this was one of those times when it paid off."
Keep Your Eyes on the Prize -- and Your ScoreHaving a credit score in the top tier (740+) and over 50 percent equity in her home put Calame in the enviable position of qualifying for the cheapest mortgage, says Carolyn Warren, author of "Homebuyers Beware: Who's Ripping You Off Now?" She says a little more than 40 percent of Americans have a credit score in the top tier, qualifying them for the best loans at the best rates. Not top-tier? Not even close to the threshold? Warren says homebuyers with lower credit scores can take heart. "If you had a chapter 7 bankruptcy two years ago, old collections or charge-offs, late payments, or your score is sub-top tier, you might still qualify for a good loan," she says. "The FHA loan offers an excellent 30-year fixed rate. Most lenders look for a score of 620 and clean credit for the past 12 months."
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How Much is That Mortgage in the Window?That can depend on your credit score, but it wasn't always the case. In the past, with a conventional Fanny and Freddie loan, you only had to meet the minimum requirement, explains Denver-based mortgage broker Todd Huettner, president of Huettner Capital. As long as you had a credit score of 620 or higher, everybody paid the same interest rate, assuming you had a standard full-documentation loan -- one that requires proof of all income, assets, and liabilities. Now, all loans are full-doc, says Huettner. Starting at 740 and going down every 20 points, you may have an adjustment depending on your loan-to-value. (Adjustment meaning, to keep the same interest rate you have to pay x amount in fees.)
Most lenders use a private rate sheet (or matrix) where they find your loan-to-value, find your credit score, and where it meets is your adjustment (or points you might have to pay to keep the best rate). "It's a very simple thing to read but it's very new and most people didn't realize this was occurring," says Huettner. "For people who have marginal credit, the adjustments can be fairly significant -- especially if you're doing cash out." According to Huettner, what used to be considered "good" credit is now merely "average." Typically, if you're doing stated income, anything over 720 there was no adjustment and you can even go down to 680 with a minor adjustment. Now, 740 is the new minimum not to have any risk.
Why Every Point MattersThere's no such thing as a teetering credit score being "close enough," says Huettner. He tells it like it is: "719? Tough, you're not a 720. You are thrown in the pool of people who are 700-719. Doesn't matter where you are, you are the same guy. If you're a 699 -- sorry, you're down in the lower tier." It could be the difference of a half of a point or a point of jumping from one tier to the next.
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-- How your credit score impacts where you live
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One point on your credit score could cost you one point on your loan to keep the same rate. According to Huettner, if you're at a 710, your first nine points in either direction won't matter, but if you're right at a 699, that one point just cost you one percent of your loan amount -- which can be thousands of dollars.
Seize the DayToday, banks are being much more stringent providing credit to homebuyers, and mistakes in your credit history are anywhere from costly to lethal, says financial expert Ron Insana, daily contributor to CNBC and TheStreet.com's Market Movers portfolio. He says it truly pays to be diligent about maintaining a credit score as high as possible, given the opportunities for real estate that exist right now.
According to Insana, there's a chance to buy a very good piece of property at an extraordinarily reasonable price, but if you've messed up your credit history, you'll miss the boat. "Now, it's going to be that much more difficult for you to take advantage of what is very likely a generational opportunity in real estate. Prices have come down dramatically in a great number of cities in this country, desirable cities like Miami, San Diego, and Henderson, Nevada."
Stack the Deck in your FavorIf you have credit card debt that's excessive, pay it down as quickly as possible, advises Insana. If you're vying for a mortgage, you want to not only make sure your payment history is clean, but your outstanding credit balances are as small as possible, if not completely wiped out. "That's the one thing about credit -- it's always a double-edged sword," says Insana. It can help you if you're struggling a bit and serve as an income extension, but it has to be managed. It takes a lot of time to build trust among lenders that would allow you to move forward with your financial life."