My parents are trying to convince me to buy a house because mortgage interest rates are so low now. Plus, they are noticing that homes in my area have become more affordable than they were just a couple years ago. I’ve got a decent job and no debt (besides student loans), but my credit isn’t fantastic. It’s 630. My parents keep reminding me that they were dirt poor when they got their first house — and that if I wait until I have perfect credit, I’ll “miss the boat.” I guess I’d just like to know if waiting (and working on improving my credit) is the best choice. What do you think is the ideal credit score I should have before getting a mortgage?
Great question! As you rightly assume, with a credit score in the 630s, you will end up paying a much higher interest rate on a mortgage loan. And that is indeed a predicament, because your parents are right: With mortgage rates at historic lows and house prices still recovering from the economic slump, this is a great time to buy a new home.
That being said, you will likely save a lot more by spending another year or so doing what you can to improve your credit score. Mortgage rates may fluctuate somewhat, but it’s probable that you will be able to improve your credit score faster than mortgage rates move up.
With a credit score as low as 630, not all banks will approve you for a mortgage, and those that do will charge you a premium of 1.5 percent or more for the loan. You can use this handy
Loan Savings Calculator from FICO to find out exactly how much money that will translate into over the life of the loan amount you’re targeting.
For example, let’s assume you take out a $150,000 mortgage to purchase the house. At your current credit score, the interest rate on a 30-year fixed mortgage will be 5.103 percent (according to the FICO calculator), compared to 3.51 percent for people with excellent credit (a score above 760).
If your credit score increases by just 15 points, to 645, your interest will go down to around 4.56 percent, saving you $17,850 over the life of the loan. Bring your score above 700, and you will save more than $43,000 over a 30-year mortgage period. And if you get above a score of 760, you get the lowest interest rate available and save more than $50,000 over the life of the loan.
The interest you pay for a mortgage not only affects the cost of the loan, but also how much of a house you can buy. Let’s say you can afford a monthly mortgage payment of $800 (after covering the cost of property taxes, maintenance and utilities). At your current credit score, the maximum mortgage amount you can afford is $150,000. However, by increasing your credit score to above 700, you can afford payments on a mortgage of $175,000.
There is more to consider than just the mortgage interest rate you will end up with, however. You say that you have a decent job and no debt other than student loans — so for someone in your situation, your credit score of 630 is unusually low. Since you don’t mention why your credit score is so low, I can’t speak to your credit management skills. However, a score in that range is usually a red flag that, for whatever reason, you have not managed credit very well in the past.
If that is the case, you might run into other issues besides having to pay higher rates on a mortgage loan, if you do buy a house. Credit scores are not just useful indicators to banks, they can also be useful to gauge your own knowledge and skills when it comes to managing money in general and credit in particular.
It might behoove you to learn more about credit scores, so you can understand which habits or actions have caused your score to be so low. Once you buy a house, poor money-management habits will have much more dire consequences than just affecting your FICO score.
Losing a house because you can’t pay your bills is no fun; you don’t want to invite that stress into your life.
Last, but not least, you don’t say whether you have saved up money for a down payment on a house. If you haven’t, that should be the first place to start. It will help you create habits around budgeting and saving, which are money management skills you will need anyway in your future life as a homeowner.
In sum, you’d do yourself a favor by spending at least a year tackling that
low credit score before venturing into a house purchase. Again, this isn’t just about the rate you’ll be paying for a mortgage — it’s about the money and credit management skills you bring to the table. And the habits you need to improve your credit score are the same habits you will need to be able to comfortably meet those mortgage payments once you do buy a house.
Owning a house is great, but only if there is no financial struggle involved. If paying the bills is a strain each month, believe me, it’s not worth it — no matter how low those mortgage rates currently are.
Got a question for Eva? Send her an email.