Since the economic crisis in 2008, it has become increasingly clear that borrowers with lower credit scores are more likely to default on their loans than people with high scores. Due to this risk, the requirements for credit scores have become stricter. Individuals with bad credit scores are less likely to be approved now. After approval, the main difference for a person with a low score and a person with a high score is the interest rate. If you have a bad score, you’ll be given a higher interest rate on your mortgage.
The most commonly used credit score is the Fair Isaac Corp. (FICO) score. It is calculated using five categories:
- Your history of making payments
- The amount you owe
- How long you have had credit
- Your recent or new debts
- What type of credit you have
Most lenders use tiered pricing, which means that the interest rate goes up as the credit score goes down. However, different lenders may have different cut-off points for their interest rates. You need to research lenders for to find one that offers the best rate for your score.
A low credit score does not mean you’re ineligible for a home loan. You will simply have a high interest rate attached to your home loan. By making regular payments on your home loan for two to three years, you can raise your credit score and then refinance your home loan for a lower interest rate.
Lenders will look closely at the reasons for your low credit score. If you have failed to repay minor debts or have had a major illness that set you back financially, they could give you a better interest rate than the rate they give other people with bad credit scores. If the score is low because of a consistent record of failure to repay, with several repossessions and even bankruptcy, it could be almost impossible to get a home loan.
It is worth raising your credit score before applying for a home loan. High interest rates over the term of your loan can amount to tens of thousands of dollars. If you can wait to buy your own home, try to raise your bad credit score into at least the middle range. That way it will be easier to receive loan approval and it will make your payments more manageable.
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