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How Your Credit Score Affects How Much House You Can Buy

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In today’s mortgage market, credit score has a massive impact on loan eligibility, rate, and amount. Qualifying for a mortgage loan has gotten trickier since the housing bubble collapse in 2008. Lenders have tightened their credit-score requirements. In this post-bubble era, low rates require both a good credit score and a hefty down payment. Gone are the days of “No Income No Asset loans,” which were often available to people with modest credit scores. Now banks want to see long, solid payment history and a down payment that assures them the borrower has some skin in the game.

For potential borrowers, this isn’t bad news. The lax mortgage qualification standards before the housing crash created an unprecedented bust. This colossal miscalculation cost millions of Americans their homes and millions more the equity in their homes. Many homeowners worked for years to build the equity that vanished. Today’s mortgage market looks much more stable than the 2000s. For more insight into today’s real estate and mortgage market, read the Rusty Tweed website.

Though this may be good news for the stability of the housing market, it understandably causes some trepidation amongst potential home buyers. With exotic loan products long extinct, buyers can expect to face steep interest rate increases if their credit scores are sub par. Even those with on-par credit scores see increases if they lack a substantial down payment.

How your credit score affects how much house you can buy

Loan Amounts

Credit scores affect loan amounts because lenders use the debt-to-income ratio in determining the maximum loan amount, according to Lending Tree. Debt-to-income ratio is comprised of all of the borrower’s debt compared to the borrower’s stable monthly income. For example, if a borrower’s debt payments total $2,000 per month and his or her gross income totals $4,000 per month, the debt-to-income ratio is 50 percent.

When evaluating a mortgage application, the lender adds the mortgage payment on the property to be purchased to all the applicant’s other debts. This determines the maximum purchase price the lender will allow. If the borrower wants to purchase a property that would cause their debt-to-income ratio to rise too high, the bank denies the loan request.

Interest Rates and Down Payments

Credit score matters because the interest rate the bank charges ties directly to credit score. The higher the interest rate, the higher the mortgage payment. This can drastically affect the debt-to-income ratio. A lower interest rate allows the borrower to qualify for a larger loan.

One way to overcome a low credit score is to have a large down payment. Lenders often view customers with large down payments and low credit scores as better risks than high credit score customers with little money to put down. A strong investment strategy can help your savings grow into a large down payment, as financial advisers like Rusty Tweed can attest.

Improving Your Credit Score

Before applying for a home loan, Nerd Wallet suggests taking some time to maximize your credit-score potential. The first step is reviewing your credit history and credit score. If you have a lot of room for improvement, you may want to wait on that home purchase until you can raise your score. Here’s how:

  • Make payments on time
  • Pay off credit card debt
  • Avoid opening new accounts

On-time payments are the number one factor, but your revolving balance also means a lot. Credit card debt reduces credit score, especially if it exceeds 30 percent of available credit. It also increases the debt-to-income ratio. Credit scoring formulas favor older accounts over newer accounts. If you’re close to buying a home, keep your old accounts and don’t open any new ones.

While perfecting you credit, also beef up your savings. A bigger down payment saves on interest rate and increases the price range of the homes you qualify to purchase. It also saves thousands in interest payments over the life of the loan. There are many investment options to help you grow your down payment nest egg. With some disciplined savings and a close eye on your credit profile, you can save tens of thousands on your mortgage.

To find out more about how to successfully invest in Los Angeles-area real estate, visit the Rusty Tweed website.