For most people, your home is the biggest purchase you’ll ever make. You borrow a high dollar amount and take 30 years to pay it back. Lenders make money by charging interest, the amount you pay for the privilege of borrowing from them. If you have a low credit score, lenders assume it’s a bigger risk to lend to you.
If you have trouble paying your car note or credit card payment on time, they reason you’ll probably also be late on your home mortgage payment. During that time frame, they’ll have less to lend to other borrowers. They might have to expend manpower to hassle you before you get around to making your payment.
If you have defaulted on other debt, you’re an even bigger risk. That signals you can’t always come up with the funds to pay what you owe. Lenders worry they might loan you thousands and later get stuck with the note.
If you have poor credit, you may still be able to get a bank or other lender to give you a home loan, but they’ll charge a higher interest rate. You pay more to borrow the same amount.
Calculating the Cost
Everybody pays interest when they get a home loan, so is there really that big of a difference? Let’s say when you buy a home, you finance $200,000. Like most people, you get a 30-year mortgage. If you have pretty good credit, you might borrow that money at 3.75 percent interest. If you do, your monthly payment just on the principal (not taxes, homeowner’s insurance or PMI) is $926.23.
Over the lifetime of your loan, you pay $133,443.23 in interest.
Let’s compare that to someone with a credit score between 620 and 639. They qualify for a home loan at 5.48 percent interest. Their monthly payment goes up to $1,133.07 plus taxes, homeowner’s insurance and private mortgage insurance.
They pay $207,905.06 total interest on their loan.
They pay $206.84 more every single month for the same house. Over the term of the loan, it costs them $74,461 more to borrow the same amount of money.
Think of what you could do with that kind of cash if it stayed in your pocket. For most families, $200 a month is too much to just give away.