Credit scores, down payments, and mortgage interest rates
Question: If your credit score is low enough to get you a high interest rate on a mortgage, can you reduce the interest rate with a bigger down payment? How big does the down payment have to be to get the best possible interest rate, as if you had perfect credit? Do most banks do it that way, or only a few specific mortgage companies?
Answer: There are a few ways a borrower with high scores can get a better interest rate and you have touched upon one of them. Increasing your downpayment to anywhere between 70-80% of the value of the home (LTV), would have a positive effect. Another option is to use discount points to pay down the interest rate.
I don’t suggest you do any of this though…I recommend that you get a no-cost loan (no discount points, min. down payment, etc.) and view this loan as a “bridge” loan to better credit. As you most likely want to refinance out of this loan was your credit score has improved, why would you want to buy down an interest rate on a loan that you intend to get rid of? Once your credit score has improved, you can invest in buying down the interest rate when you refinance. That sounds good in theory, but I wonder how long it actually takes for a credit score to improve. It doesn’t happen after just a year or two of payments on a bridge loan being made on time, especially if other financial issues have not been resolved. And for somebody with bad credit, the interest rate on that bridge loan must be enormous. Credit score improvement timelines depend on the type, qty and severity of issues involved as well as the approach in which one takes to improve it. The use of rapid rescoring can bring about improvement immediately (I just assisted someone that has been in bankruptcy for 2 years with a mid score of 540, improve this by 47 points). Check out this link for further details on rapid rescoring; http://moneycentral.msn.com/content/Banking/Yourcreditrating/P38050.as
pMy advice in layman terms is don’t buy down the interest rates of a less then perfect credit loan if you are confident you are going to refinance after your credit score improves. Why? Because you are investing your hard earned money in a throw away loan. Better Alternative? Take the less then perfect loan at no points/no closing costs and invest in discount points when you refinance into a prime rate loan.
Let’s put my “theory” to the test in today’s interest rate enviroment.
Less then perfect credit loans currently range from 9-13% in today interest rate enviroment depending on the credit issues and severity for a no points purchase loan.
Prime rate mortgages currently range from 6.75~6.875 for a no points purchase loan.
YOUR THEORY: Purchase down the high interest rate with discount points. MY THEORY: Don’t invest anything into this throwaway loan.
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