A large red percentage sign sits on a roller coaster symbolizing the ups and downs of interest rate … [+]
When you see interest rates advertised on the world wide web or in newspaper ads, on open house flyers, in bank lobbies and everywhere else, they are always the interest rates that are available to high credit score borrowers. Lenders never advertise their average interest rates or their low credit score borrower interest rates. The best rates for the best borrowers always make the headlines, that’s how it works.
But maybe your credit score has suffered as the result of past credit misdeeds or is a little banged up from bills that may not have gotten paid on time. If you struggle to manage easy-to-get credit like millions of other consumers do or maybe your student loan debt is an issue. Maybe unemployment or illness disrupted your household cash flow and you fell behind and struggled to catch up, then the interest rates available to you can be very different from what you see advertised.
“Very different” is code for higher, a low credit score may mean a higher interest rate.
Imagine two soon-to-be-neighbors, both applying for $300,000, 30-year fixed rate mortgages to buy nearly identical houses. These two prospective home buyers are very similar except for one significant difference; one has a 750 credit score, the other clocks in at 620.
The 750 neighbor gets the shiny 3.75% advertised rate and a $1,390/month mortgage payment. Neighbor 620 on the other hand has to settle for a 4.50% interest rate and pays $1,520/month! The lower credit score resulted in an interest rate that is .75% higher and mortgage payments that are $131/month more. So yes, your credit score really can affect your interest rate.
Neighbor 620 can in fact get the same 3.75% interest rate that Neighbor 750 got, but will have to pay points to buy that 4.50% rate down to 3.75%. It may cost between 1 and 2 “points” or $3,000 to $6,000 to get the same 3.75% interest rate that Neighbor 750 got at no extra cost.
Credit scores impact interest rates.
Risk based pricing has been the industry norm for almost as long as credit scores have been around. The Consumer Financial Protection Bureau defines risk based pricing right there on their website; Risk-based pricing occurs when lenders offer different consumers different interest rates or other loan terms, based on the estimated risk that the consumers will fail to pay back their loans.
This means, for example, that lenders will generally offer a higher interest rate to you if they view you as a higher risk borrower – say, because you recently declared bankruptcy, lost a job, or are several payments behind on a mortgage. For the same exact loan, lenders will generally offer a lower interest rate if they view you as a lower risk – say, because you have a good credit score and are employed.
If Neighbor 620 opts not to pay $3,000 to $6,000 in extra closing costs or points to buy down the interest rate, the additional cost over time can add up.
After a while Neighbor 750 and Neighbor 620 become good friends, they have kids that go to school and play sports together, they barbecue when the weather is nice and share a snowblower when it’s not. Eventually, their kids grow up and move away and both neighbors start to think about downsizing and selling their homes.
15 years have passed since they bought their nearly identical homes with their different credit score/interest rate mortgages, and both homes should sell for about the same price.
Over 15 years, Neighbor 750 has made a little over $250,000 worth of mortgage payments and managed to pay off almost $109,000 of that $300,000 mortgage.
Neighbor 620 has made $273,600 worth of mortgage payments and paid off about $101,300 of the $300,000 originally borrowed.
That 620 credit score cost $23,600 more in total mortgage payments paid and resulted in $7,700 less mortgage principal paid; a $31,300 difference between the two!
That is how much your credit score can affect your interest rate.
If you identify more with Neighbor 620 than you do with Neighbor 750, there is good news. You can do something about it!
Get to work on addressing those things from your credit past that are hurting your credit score. Start by obtaining a copy of your credit report at AnnualCreditReport.com and see what it says. Look for discrepancies or maybe there are items that you have paid that are not reflected correctly on your credit report. Consider working with a reputable credit repair service or an experienced mortgage rep to evaluate your current credit circumstances and create a road map that will get you closer to Neighbor 750.
Credit scores are up to the moment snapshots of your credit profile. Fix what needs to be fixed, keep current debts current, get good advice and use it and stick to it.
And remember how much your credit score can affect your interest rate.