I’ve Got Good Credit. Why is my Rate so High?
By: Drew Tyler | Posted: 28th August 2007
Are you looking to refinance? Maybe you want to purchase a new home. Don’t listen to all of the media hype surrounding mortgage rates and expect to get the rate that you hear advertised. Even if you have perfect credit, you may have a higher rate than you think you should. Read on to find out why.
There are three main components to a loan. They are credit, collateral, and capacity – known as the three C’s. Credit is just as it sounds; it is your credit score. Collateral is the value of the home. More importantly, it is the value of the home compared to the amount of the loan. Capacity is your ability to repay the loan. Let’s examine each one and see how they affect the terms of a loan.
Credit is the first thing that a loan originator will examine when they are trying to qualify someone for a new mortgage. A credit report is obtained along with the credit scores (FICOs). The person’s credit history is examined for items such as late payments on previous or existing mortgages, late payments on other debts, collections, liens, judgments, bankruptcies, etc. The credit report typically will contain three FICOs – one from each credit bureau. The middle score is the one that is used for qualifying the borrower. At the time of this writing, the mid-score needs to be in the mid 600s for a borrower to obtain the most competitive rates.
Simply having good credit though, doesn’t guarantee you the lowest possible rate. The second “C”, collateral, plays a big part in determining your rate. If you are borrowing 100% of the value of your home, the lender is assuming more risk. Consequently, the lender is going to require a higher interest rate. If you are borrowing, say, 60% of the value of your home, the lender is assuming far less risk and is willing to lend money at a lower rate of return. The lingo for this portion of a loan is “LTV” which stands for loan-to-value ratio, and is calculated by taking the amount of the loan divided by the appraised value of the home.
Capacity, the third component that we are discussing, is simply your ability to repay the loan. Your ability to repay a loan is determined by calculating your debt-to-income ratio; this is also known as “DTI.” The DTI is determined by first taking all of your revolving consumer debt – credit cards, student loans, auto loans, mortgages, lines of credit, installment loans (basically everything that reports on the credit report) – and adding up your monthly minimum payments. After we have a sum of your monthly payments (outgo), that number is simply divided by your gross monthly income (income before taxes). Keep in mind that your DTI does not include daily expenses such as daycare, gasoline, groceries, phone bills, etc.
These three items represent the overall risk picture of a particular borrower. The borrower may have a 800 FICO score, but if their DTI is 80% and they are trying to take a 100% loan, they shouldn’t expect the same interest rate as another borrower with 700 FICO, 22% DTI, and 75% LTV.
Now you understand that there is more going into determining risk than just your credit score. Don’t get me wrong, your credit score is probably your biggest ally, or it can be your greatest foe (if it is really low). If your FICO is 790 and you are offered a rate that seems higher than what you expect, think about these other mentioned attributes. However, if they too are in order, I suggest you find a better mortgage specialist.
About the Author
--Drew Tyler is an experienced and successful mortgage professional. To gain more insight into the mortgage industry, and make yourself a more educated borrower, please visit www.competingloans.net.Click here for a FREE report explaining how to be debt-free and a millionaire in 30 years!Click here for a FREE report on some detailed steps you can take to protect your credit and identity!
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Tags: debts, credit score, credit scores, credit report, interest rate, new mortgage, collateral, judgments, mortgage rates, credit history, ltv, late payments, rate of return, bankruptcies, media hype, credit bureau, loan credit, value ratio, lingo