First and foremost I believe there is still some misconception by consumers of what credit scores are! Secondly, consumers must understand that there are no...I repeat NO catchall rates and loan terms that apply across the board to consumers. It's all about risk assessment by the lenders whether you are getting an auto loan, credit card or a mortgage loan.
As an example, if you hear that the national average for 30 year fixed rate agency loans is 5.25% this is not what you can expect if you just have "good" credit. You can have excellent credit/pay all your debts on time but a low score due to a risk assessment.
Likewise it is important to understand that this also applies to higher rates/fees charged by Private Mortgage Insurance (PMI) companies to insure your conventional mortgage loan. These fees have skyrocketed in the past couple of years.
Many consumers may still understand or believe that their personal credit scores are a numerical evaluation of how they have handled their past credit. Quite contraire....your personal credit score is a predictive risk model or an indication of increased risk of the likelihood that you may or will experience future credit problems whether it be in the form of late payments/delinquency, default, collections, bankruptcy, etc.
All lenders use some form of tiering of credit scores to either grant or decline your credit request as well as price the cost/rate of your loan to you. In the case of credit cards you might receive a credit card with an interest rate of 8.99% based on your credit worthiness at the time the credit card is issued. The credit card companies monitor your credit file/score frequently and if you add excess debt or you credit score drops you could reasonably expect a notice in the change of your terms.....maybe to 27.99% virtually overnight.
So...on to the subject matter or title of my post. Depending on your credit score, loan-to-value %, type of loan and purpose, your credit score could cause a pricing adjustment in some extreme cases as much as 3.50%..yes .....I said 3.50%!
To illustrate my point that higher credit scores can put money in the bank for you, let's make a few assumptions and crunch the numbers. Assuming that national mortgage rates for 30 yr fixed rate are at 5.25% and you are obtaining a mortgage loan of $100,000 (purchase or refinance), however your personal credit score is low enough to cause a rate increase to 6% after price adjustments are calculated. A $100k mortgage at 5.25% equates to a monthly principle and interest (P & I) payment of $560.49, however since your credit score was lower your actual monthly P & I payment will now be $608.54, a monthly differential of $48.05.
Assuming that you will reside in your home for 7 years, that you had protected your credit score to avoid paying a higher interest rate and that you have the financial discipline to save or invest this monthly differential of $48.05 you would have accumulated just over $4000 in this period of time.
Let's add some more "what ifs"! Let's assume that you took out a mortgage loan that required private mortgage insurance (PMI) and your lower credit score also caused an increase to the cost of your monthly PMI premium. While there are many variables to how this cost may impact you...it can be significant! Conceptually, apply this situation to all your personal debt, auto loans, credit cards, etc. Also consider the earnings on these savings or investments over the next 7 years. $10,000, $15,000 in the bank....or more?
Bottom line is there will always be a cost of using credit but the ability to make it pay you... is up to you!
Copyright 2009, Ron Withers, All Rights Reserved
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Have always liked the name of your city, still the Strawberry Capital of the world? You're right about credit scores and it always amuses me how customers with low scores always want to blame the system. Pretty soon, we'll have to start learning about the new credit scoring system, just what we need at this time!
Hey Ron: I am constantly urging my clients to make every effort to bolster their scores before jumping into the housing market. There still seems to be a "disconnect" with these folks(especially the younger ones) with regard to the importance of handling their credit wisely. Thanks for your post.