Heather McClane still believes in the American Dream. Even now, five years after the mortgage bubble burst and with lingering uncertainty about the housing market and the economy as a whole, McClane desperately wants to stop renting.
"I want a home so badly for my family," she wrote in response to a Credit.com story, "especially my children."
McClane's dream of homeownership is further clouded by her own unpaid bills. Four years ago, McClane entered a hospital and racked up a $25,000 bill, which she never paid. That lingering unpaid bill is causing her credit score to remain stuck at 709, she says.
"Five years ago, 709 wasn't too bad," says Barry Paperno, Credit.com's credit scoring expert. "Nowadays it's pretty terrible. But it's not far from being good."
'A Credit Score Is Not a Report Card'
Between her low score and her unpaid hospital bill, McClane is finding it impossible to get a mortgage.
"I am unable to get a loan due to the massive unpaid medical bill!" McClane writes.
Here's the surprise: Maybe that's not such a bad thing. According to some credit experts, it's not necessarily an injustice that consumers like McClane can't get mortgage loans. After all, from the point of view of a prospective lender, an unpaid bill in the past might signal that a consumer will forego paying a loan in the future.
"A credit score is not a report card," Paperno says. "It doesn't look backwards in time. Rather, what it does is look forward and try to predict the likelihood that someone will repay a loan in the future."
But what if McClane's inability to buy a home right now is actually in her best interest, too? As we've learned from the bursting mortgage bubble, homeownership comes with risks. Even as the housing market begins to show its first signs of prolonged health since 2008, here are five reasons why people with damaged credit maybe shouldn't buy a house right now.
1. Home Prices May Still Go Down
Just because prices have stabilized in most cities for the last few months, there is still an excess inventory of about 2 million homes in the United States, according to an estimate by A. Gary Shilling, a financial analyst. "That is huge," Shilling wrote in The Wall Street Journal in May.
That means home prices, which already have tumbled 36% from their peak in 2006, will probably keep falling, Shilling says. That's especially true since many sales moving forward will be on previously foreclosed homes, which sell at a 19% discount compared to similar homes.
"At current rates of housing starts and household formation, it will take four years to work off the excess inventory, plenty of time for those surplus houses to drag down prices," Shilling says.
2. Bad Credit = Higher Rates
Forget all you've heard about record-low interest rates, which are hovering at about 3.5%. If you get a mortgage with poor credit, your interest rate will be significantly higher, warns Gerri Detweiler, Credit.com's consumer credit expert. That high rate will cost you lots of money in coming years, no matter what happens in the broader economy.
"You may get stuck with a high interest rate and not be able to refinance it in the future if the rates go up," Detweiler says.
If you're curious to see how much it'll cost you to get a loan with poor credit, check out this handy calculator. Let's assume McClane purchases a new home, which currently sells for a median price of $224,200, according to the U.S. Census Bureau. With a perfect credit score and the lowest-available interest rate, she would pay $144,383 in interest over the life of a 30-year mortgage, according to the calculator. Now let's assume McClane purchases the same house, but her low credit score gives her an interest rate of 9%. That causes her interest costs to multiply, forcing her to spend $428,669 just on interest.
If McClane is daunted by a debt of $25,000, imagine how she might pay a six-figure interest charge. Instead of rushing to buy a home now, she may be better off postponing such a major purchase until she can build her credit score, since doing so could save her much more than the $25,000 she owes.
3. Few Affordable Houses to Buy
Home prices plummeted after 2008. Many people who paid boom-era prices for their homes now find themselves deep underwater, and many are refusing to sell. Those houses tend to be precisely the kind of smaller, less-expensive starter homes that first-time buyers like McClane want to purchase, says Lawrence Yun, chief economist for the National Association of Realtors.
"There are notable shortages in the lower price ranges which are limiting opportunities for first-time buyers," Yun said during a press conference.
4. Beware the Cash Trap
Making the down-payment is only the beginning. Once a consumer like McClane has purchased a home, she is in for a host of new expenses. That includes insurance and taxes, as well as unexpected things. Without sufficient money in the bank, those unexpected bills could hurt McClane's ability to pay her mortgage.
"You might use up all your cash for the down-payment and then you don't have a cushion in case the house needs repairs or you have other unexpected emergencies," Detweiler says.
5. A Big Purchase Now Actually Hurts Your Credit
It's a little-known phenomenon that getting a new loan or credit card now actually hurts your credit score in the short term, Paperno says. That small dip could spell big problems, especially if your new home requires other credit purchases, like a loan for a pickup truck or a credit card from Home Depot.
A lower score could make it more expensive for you to borrow money, and it might even make it impossible for you to get new credit at all, especially if your credit score is already low.
"Buying now could lower your credit, which could make other forms of credit more expensive," Paperno says.
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