As someone who works in the world of real estate I am frequently asked “so what is the current interest rate?”. Well- there is not just one set answer. Determining the interest rate you may pay (mortgage,car, credit card) is determined by several things–one of which is your “FICO” score.
Before 1956 your ability to get a loan was determined by your trustworthiness and reputation to your local bank–they looked at your job history, bills and potential income and determined if you were a suitable risk. No real standards across the board. In 1956 an engineer and a mathematician developed a scoring system that helped to determine your risk– the higher the score the less risk involved in creating a loan. This became known as Fair Issac scoring and then FICO became public in 1987.
Thanks to Jeff Kardel (a loan officer at Rand Mortgage) for the information below which helps to make it a little more understandable:
The Five Main Factors Generating FICO Scores
1. PAYMENT HISTORY (35%) . . . My Tip: Pay all accounts on time allowing for payments to process.
• Paying debt on time has a positive impact. Late payments, judgments, collection accounts, and charge-offs have a negative impact. The more recent the derogatory information, the more it lowers credit scores.
2. UTILIZATION – Amount owed on accounts (30%) . . . My Tip: Keep revolving balances low relative to the reported limits, even if you pay accounts in full each month.
• The ratio between your outstanding balances and available credit limits or reported high credit amount is important. Keep your balances below 50% of their limit. Your overall debt ratio is calculated as well as per account.
3. LENGTH/YEARS OF CREDIT HISTORY (15%) . . . My Tip: Keep oldest revolving accounts open and active.
• This marks the length of time a particular credit line was established. A seasoned borrower is strong in this area. Be careful when closing accounts to make sure you are not closing the accounts that have been established the longest.
4. NEW CREDIT AND INQUIRIES (10%) . . . My Tip: Be careful not to have your credit pulled unnecessarily and too often, and do not apply for a new credit card while you are in the process of applying for something as important as a mortgage.
• This quantifies the number of inquiries that have been made on a consumer’s credit history. There are hard and soft inquiries. Hard inquiries are generated by creditors when you apply for credit and they do impact your credit scores. Soft inquiries are generated if you, as a consumer check your credit by contacting the credit bureaus, or if creditors check your credit in an effort to potentially offer you a new product or service, extend an existing line of credit, or to make sure they are comfortable with your credit standing. Soft inquiries do not impact your scores.
5. TYPES OF CREDIT USED (10%) . . . My Tip: Establish and keep a well rounded credit profile.
• A good mix of auto loans, credit cards and mortgages is more positive than a concentration of debt from credit cards only, or mortgages only, etc. In fact certain scoring models require at least two open active revolving accounts to generate scores.
So how does this relate to buying a house? The higher your score the better the terms and rates you may encounter. That is why there is no “one size fits all” interest rate.
Jeff provided some good tips to improve your score. I would like to suggest a few as well that have worked for me.
Traditionally when you are trying to pay off multiple credit cards and loans you are told to pick the one with the highest interest rate or highest balance and pay that off first. It kinda makes sense because that might be the one costing you the most in interest….however, my suggestion (and again I am not an accountant so I am not offering ‘professional advice’) is to make payments on all cards and loans on time BUT take the one with the least balance and pay off as much as you can to eliminate this loan. THEN—take the money you were paying on that credit card/loan and apply it to the next lowest balance. WHY?? Because you will actually see that your debt is shrinking and be able to stick to the program. Most people have a hard time sticking to a program where they see little results (think about dieting when nothing is happening to the scale).
One other thing I would suggest to someone thinking about buying a home. Sit down with someone, if you are ready to be serious about becoming a home owner (notice I didn’t say “to buy a home”) and find out what kind of budget you are comfortable with.
This is something I can do–by finding out what you are comfortable paying EACH MONTH and not as a total price for a house I can work backward to tell you what price range you should look in to keep it in that budget. If that amount is more than you currently pay in rent, try putting aside the difference in a separate savings account for 3-6 months to see if you still feel comfortable with that amount—but don’t consider it money you can use-consider it spent. If you are not comfortable and it is a struggle to set aside that much it is better to find out before you commit to a house and mortgage. If you are happy and comfortable ‘paying’ that amount then you have that much more money saved and it can be used as a ‘reserves account’ for future repairs or new things for the house. Continue to put away the difference (and extra) even after you have determined your comfort level–repairs will be needed and it is better to have 3+ months of payments in reserve (if possible) to eliminate/reduce credit card use.
Either way, the idea is two fold: get in the habit of saving and paying for things in full (rather than a credit card ) and thinking of your future as an investment. Second–you will actually be able to enjoy being a homeowner– rather than ‘house poor’ and a slave to maintaining the house–you will have the ability to have a vacation, go to the movies or out to eat because you chose to buy within your current budget –not one set by someone in a bank.