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Score Big

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Posted On: 08/31/2016

Question: My husband and I both have solid credit scores above 800. Our mortgage lender is very happy about this, but how do we actually benefit? How much can we save?

Answer: Let’s start with a mortgage application. Different loan programs have different requirements. These requirements can include such things as a maximum loan size and a minimum down payment. Another requirement can be that the borrower must have a certain credit score.

For instance, in theory you can get an FHA loan with a 500 credit score, however anything below 580 requires at least 10 percent down instead of the usual 3.5 percent up front.

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In reality, the odds of getting an FHA loan with such a low credit score are dismal: the FHA’s 2015 annual report to Congress showed that less than .3 percent of all FHA loans had credit scores below 580 and fewer than 6 percent were less than 620. Less than 20 percent of all FHA borrowers had credit scores higher than 720, most likely because borrowers with higher scores have more choices and can finance with different loan options.

Not only do high credit scores remove a major application barrier, they’re also worth money in your pocket. Big money.

MyFico.com has a loan savings calculator that illustrates the benefit you can get from a solid credit score. The calculator shows various credit bands and how they translate into mortgage rates. For instance, in the MyFico model, if you have a credit score below 620 you might pay 4.88 percent while someone with a score above 60 will pay 3.291 percent. For someone borrowing $150,000 the monthly payment will be $794 with a low score versus $656 in the highest band. That’s a difference of $138 a month, $1,656 a year and $8,280 over five years.

However, even if a borrower has the ability to pay the higher monthly cost, they may have a tough time qualifying. The reason is that most loans today limit debt payments to not more than 43 percent of the borrower’s gross monthly income. An extra $138 a month combined with student loans, auto financing and credit card bills can put marginal borrowers over the limit, meaning less financing for them and maybe not enough to buy the house they want.

If you have a low credit score it will take some time to push it higher, however here are three steps that can significantly increase your credit standing.

First, bills are not a luxury. They have to be paid so it makes sense to pay them in full and on time.

Second, create a budget and track where your money goes. Where are the three places you can instantly cut costs? Use the money you save to pay down debts.

Third, stop opening new credit accounts. Unfortunately, it’s easy to open a new line of credit without being aware that doing so pushes down credit scores.

For instance, why pay full price for that new chair? The store will offer a 15 percent discount if you put the bill on their credit card. That new credit card is simply a new line of credit, which will make it harder to raise your credit score. In this way, the lure of a minor discount can raise your costs for many purchases and maybe doom a mortgage application.

The better alternative: Buy only when you have the cash to make a purchase.

Peter G. Miller is author of "The Common-Sense Mortgage," (Kindle 2016). Have a question? Please write to peter@ctwfeatures.com.

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