How Can Bad Credit Affect Mortgage Terms?

Stop. Before you use that charge card again, or blow off that bill payment, think about how it might affect your home.

The issue here is your credit rating, and what's at stake is your ability to buy a home or keep the one that you're in. Too many homeowners have seen bad credit affect mortgage conditions, and that can make the difference between owning the roof over your head or spending your life dependent on landlords.

The impact of bad credit on your mortgage may be felt in a variety of ways, as the next section will describe.

How Can Bad Credit Affect Mortgage Terms?

You might see bad credit affect mortgage terms in any or all of the following ways:

Availability of mortgages

Lenders tightened standards in reaction to the housing crisis, and even several years later, it still takes pretty good credit to qualify for a mortgage. For example, even with FHA mortgages, which are intended to make housing more widely available, the average credit score of FHA borrowers in the third quarter of 2015 was 681. Less than five percent of FHA mortgages went to borrowers with credit scores below 620. Back in 2009, nearly 25 percent of FHA loans were going to borrowers with such low credit scores. This is indicative of how lenders have tightened their standards since then, and that's not just true of FHA loans. Borrowers with low credit scores can expect a cold reception from lenders for any type of mortgage.

Size of down payment

Even if you qualify for a loan, you may be expected to put up a larger down payment if you do not have a strong credit rating. That extra equity up front serves as protection to the lender against the possibility that they may have to foreclose on the house, a possibility lenders view as more likely for home buyers with weaker credit scores. Having to save up for a larger down payment could delay when you are able to buy a house, and that delay could prove very costly if you miss out on today's extraordinarily low mortgage rates.

Mortgage insurance premiums

Another way lenders protect themselves in certain mortgage programs is through mortgage insurance, which insures the backer of the loan against the borrower's failure to repay. As you might expect, the greater the risk your credit score indicates that you are, the higher the premium on this insurance is likely to be.

Higher interest rates

Lenders factor default risk in when they set mortgage rates, so naturally customers with the best credit typically qualify for the lowest interest rates. With less-than-perfect credit, you may still qualify for a loan, but it could cost you more in interest – and that's an extra expense you may be paying for the next 30 years.

Loss of refinancing flexibility

Refinancing can give you the flexibility to make your mortgage more manageable in a variety of ways, including taking advantage of lower interest rates, making monthly payments more affordable by stretching your remaining balance over a longer time, or reducing total interest cost by shortening the loan. If your credit score deteriorates though, you may not qualify for refinancing, leaving you with no flexibility to change your original loan terms.

As you can see, bad credit can cost you in a variety of ways – in your ability to buy a home, in how much it costs to buy a home, or in your ability to keep your home once you are in it. Measured against the effort required to maintain or improve your credit, those costs are well worth avoiding.

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