When you see interest rates publised in ads or articles, flyers, they are always the best available interest rates if you hae a superior credit score. And when you see a “your monthly payment will only be X” they are accounting for your 20% down payment at the best interest rate available. Lenders never promote their average interest rate or their riskier borrower interest rate. They certainly don’t tell you that your monthly payment may include on average $100-200 a month in private mortgage insurance (PMI). Of course not, they want you to call them and get that lead… the best rates for the best borrowers always make the headlines.
So, Are You Interest Rate Headline Worthy?
If your credit score is a little banged up from past events or bills that did not get paid the way they were supposed to, or if you struggle to manage easy-to-get credit like millions of other consumers do, then interest rates can be very different from what you see advertised. “Very different” is code for more expensive because the interest-rate is higher. When it comes to buying a Phoenix area home, you will want to know what it means and what you can do about it.
Let’s Compare Apples To Ornges*
Take two next door neighbors with nearly identical houses looking to refinance almost the same $300,000, 30-year fixed rate mortgage. One significant difference; neighbor A has a 750 credit score and neighbor B has 620. The 750 neighbor gets the shiny advertised 4.25% rate and a $1,476/month mortgage payment. Neighbor 620 on the other hand gets a 4.75% interest rate and pays $1,565/month! An interest rate that is a half percent higher and mortgage payments that are $89/month, more simply because of the riskier credit score.
Neighbor 620 can actually get the same 4.25% interest rate that Neighbor 750 got, but will have to pay points (points = cash to lender at time of signing!) to buy that 4.75% rate down to 4.25%. Neighbor 620 can pay 2 points or $6,000 to get the same 4.25% interest rate that Neighbor 750 is getting at no extra cost. Credit scores make a difference and that is how much your credit score can affect interest rates.
Risk Based Pricing
This is called risk based pricing and it 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.
Why We Love Credit Karma
If you don’t have an account with credit karma it’s time to jump over there and check it out. (It really is free; they make their money by advertising credit cards and loans that are the best fit for where your score it.) You can watch each month how your credit score changes by doing things like paying down your credit cards to less than 49% or better yet, lower than 25% per card. You can literally gain jumps in your score by dozens of points. Have fun with it; make it a game each month! You’ll earn a better home when you do.
*Phoenix Home Guru is not a lending officer, nor do we provide legal advice. Examples are for your knowlede base only and are meant to assist you in asking better questions to a quilified professional.