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The effects of your credit history on a potential mortgage are very substantial indeed, given that for most middle-class Americans, there is no larger monthly expense than mortgage. While there are many factors that go into calculating exactly how much you will pay for your mortgage, one of the most (if not the most) important factors is your credit history.
Your credit history is of prime importance, not only because it provides lenders with a glimpse into how well you have managed to meet financial obligations in the past, but because it provides them with what is known as the all-important FICO score. The FICO score is the standard used by banks and lenders to determine exactly how creditworthy a potential borrower may be, especially in terms of a large and long-standing loan such as a mortgage.
It all basically boils down to this: the higher your FICO score (which depends upon a good to excellent credit history), the lower the interest rate the bank will apply to your mortgage. This means not only paying less each month but potentially paying tens of thousands of dollars less over the lifetime of your mortgage. In fact, according to the nation's leading mortgage experts, a person who takes out a mortgage worth $100,000 with a credit score of 520 will end up paying $110,000 more over the course of a 30-year mortgage than someone who takes out the same loan but with a credit score of 720. As any homeowner will tell you, $110,000 is no small amount.
Because your credit score is so vital to all your personal finances, it is important not just to keep tabs on what is included but to understand how it is calculated. According to FICO, the score is computed as follows:
- 35 percent: Payment history--Do you pay on time and in full?
- 30 percent: Credit utilization--This is the ratio of revolving debt in relation to total credit available.
- 15 percent: Length of credit history--The longer you pay your bills on time, the higher your score.
- 10 percent: Types of credit--The more variety of credit you utilize, the higher your score.
- 10 percent: Frequency of inquiries--The rate at which lenders make inquiries into your credit history depends on how much and how often you are applying for new credit. The more you apply, the higher your risk for default.
As you may have surmised, not every potential borrower is going to qualify for an affordable mortgage at a low interest rate. Those whose credit histories prevent them from successfully applying for a fixed-rate mortgage often fall into a category known as "subprime borrowers." These applicants are assumed to be high-risk borrowers whose ability to repay loans is considered suspect. Subprime borrowers are also considered less likely to pay credit card debt on time or beyond the minimum monthly payment.
Banks and lenders are willing to finance mortgages and loans to such borrowers but at much higher interest rates than for other mortgage applicants. They may also grant only mortgages whose interest rates rise periodically, which may also be considered a penalty. In short, all subprime borrowers should be ready to pay substantially more to borrow money until their credit histories improve.
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