credit score, mathDespite the uncertainties of the market, you have decided that 2011 is the year you will buy a home in La Habra or in the surrounding Orange County suburbs.  You’ve heard there are good deals out there, plus plenty of inventory, so you hook up with a good Realtor® and start your search.  When the agent suggests you get pre-approved for a mortgage so you can jump on a deal, your plans hit the wall:  Your credit isn’t as good as you thought it was.  You can buy a home, but not one in the price range you planned.

Even if you have done the numbers on what you can afford, it is the lender’s math that counts.  The lender looks at your record and assesses the risk it perceives on your loan.  Since the mortgage meltdown of the last few years, lenders look more carefully now.  They have also raised their requirements on two important levels: what is needed to qualify for a loan and what it takes to get a good rate.  To a buyer this translates to “Can I even get a house with my credit?” and “At what price?”

In the past, a credit rating in the high 500’s got you the right to get your keys, while a score of 700 or more assured a good rate.  Now even FHA, which technically requires a 500 score, suggests a minimum score of 620-640 for a government-backed loan, while a conventional lender would consider you a subprime risk with those numbers.  Access to the best rates – those trending at 3.5% - 4.2% these days – requires a score well over 740 in most markets.  This credit inflation impacts your purchasing power.

The higher the interest rate you have to pay, the more you will pay for the home over the life of the loan and the less house you can buy now. Every increasing percent of interest rates cuts about $20,000 off your purchasing power.  Whether the rates go up  or whether you can’t qualify for the lower rates because of your credit score, the effect is the same.  Here’s an example:

      Amount                               Interest                      Amount                   Mortgage Payment

        of Loan                                   Rate                             Paid                           Over Life of Loan

      $200,000                                  5.5%                         $1,136                                      $208,808

      $200,000                                  5.0%                         $1,073                                      $186,511

      $200,000                                  4.5%                         $1,033                                      $164,813

      $200,000                                  4.0%                             $954                                      $143,739

      $200,000                                  3.5%                             $898                                      $123,312


If you need to keep your payment around $900, you could afford a $200,000 loan if you qualify for a 3.5% loan but only a loan of $166,000 if your interest rate is 5%. You would pay over $75,000 more in interest over the course of the loan. Your choice would be to add more down payment or shop for a less expensive home.

When you look for loan approval, your lender will look at either your FICO score computed by the major credit bureaus or at your Vantage Score, another measure of credit-worthiness.  The score will take into consideration your payment history, your income, and your debt-credit ratio.  If any of the these fall short, so will your score.  A poor payment record, insufficient or spotty income, and a high debt-credit ratio spells “trouble” to potential lenders.

Given the importance of your credit score, you need to keep tabs on how your are ranked by the major bureaus.  You can obtain a free annual report from each bureau; at moment, you will have to pay for the scores themselves, but this is due to change in July.  If you find that your report shows blemishes, you should try to repair what you can before applying for a loan.  (Unfortunately, so long as the information is correct, there are no short cut to repairing it.) In general, your report should show that you have been on time with your payments and have debt-to-income ratio of 36% or less.  Your mortgage payment should take up no more than 28% of your debt, though recent mortgage modification plan have put the mortgage percentage higher.  Some lenders may be willing to offer a loan if your ratio is much higher, but the rates will be sky high.

“Lender’s math” may seem harsh, but the mortgage crisis made lenders sharpen their pencils. You may think you can afford more that the bank will give you, but short of dramatically increasing your income, your best hope of getting a bigger loan at a more favorable rate is by paying down your debt. If you want to proceed with your credit score as is, you may have to look for a less expensive home, come up with thousands more in down payment dollars,  or defer your purchase a bit.

How much do you know about credit scores?  Take this credit quiz to find out.

If you think you are ready to buy a home in Orange County, give me a call.  I can open a world of affordable choices to you, right here in La Habra, Whittier, La Habra Heights, and the surrounding area.  Keep in mind that your credit score may dictate what is affordable for you, and I will work with you within your price range.

For some interesting insights on the housing market, I welcome you to listen to my interview on the House Calls Radio show, conducted by loan officer Carlos Dandridge on area stations AM 830, 920, 1310, and 1510. 

Courtesy of Linda and Tim Domis, Neighborhood Specialists

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Listen to my interview on the House Calls Radio show, conducted by loan officer Carlos Dandridge on area stations AM 830, 920, 1310, and 1510.