If you’ve read my prior posts, you should have some good ideas about how to maintain or improve your credit score. In this post, I discuss the impact of your credit score and credit reports on home and car loans.
First, when many people take a home or car loan, they often do so with their spouse, a child, or a parent. Although the rules may vary for different states, banks, and finance companies, typically the credit reports and scores for everyone involved are examined. Of course, this results in a hard pull, which may drop your credit score temporarily, but it will recover over time.
When obtaining a large loan, it’s common for people to “rate shop,” meaning they check with multiple banks or finance companies to obtain the lowest interest rate, a larger loan, or more advantageous perks. Doing so incurs multiple hard pulls, but the credit-reporting industry is at least a little kind to consumers, because it’s often possible to combine multiple hard pulls into one so that it impacts your credit report less. This may happen automatically or you may need to contact the agency making the request or the credit reporting agencies themselves.
When applying for a home loan, typically all three major credit reporting agencies are used to obtain credit reports. Although the credit report may be investigated by underwriters in more detail later, the interest rate for the pre-approval that one obtains is based on the lowest middle credit score of the person(s) applying. So, if you have credit scores of 830, 820, and 810 from the three credit reporting agencies, 820 will be used; if you and your spouse are applying and her credit scores are 690, 680, and 670, the interest rate will be based on 680, the lowest middle score for both of you.
With the above example, you might think that it would be advantageous to apply for a home loan alone, with your 820 middle credit score. If it’s the case that both parties are bringing in income, leaving off the person with the poor credit score will impact the size of the loan that you could obtain. Long story short, if both people work, but one has a good credit score and one has a bad credit score, a choice must be made between a better interest rate or a larger loan.
The impact of a poor credit score on a home loan cannot be understated. For a 30-year loan of $250,000, someone making the minimum mortgage payments will end up paying $27,000 more over the life of the loan if he has a 5% interest rate instead of a 4.5% interest rate! Lastly, free government grants are common for home buyers and a low credit score may result in ineligibility.
When it comes to car loans, the requirements are a little easier. More banks and finance companies are involved with car loans, which are also smaller than mortgages and, thus, less risky for creditors. Interest rates on car loans are typically lower than home loans, but again the impact of a credit score can be huge.
You typically have a few options when financing a car. Many dealerships have their own finance offices and, although these may sometimes be worth looking into, their rates are often a bit higher. They can get away with this, either because buyers don’t rate shop or they just go with them for the convenience. Big banks are another option, but typically the best rates can be found at a local credit union.
When applying for a car loan, the rules that creditors use to determine the rate and/or size of the loan can vary a bit more. Because it’s a smaller purchase, it’s might be to your advantage to apply for the car loan in the person’s name who has a better credit limit.
Here’s the story of a recent car purchase. I wanted to buy a used car, went to a dealership, found the car, then started talking financing. Before doing a hard pull on my credit report, I found out that their best rate would never be any lower than 4%. I contacted a local credit union that had the best rates on car loans at 1.9%. They told me I could get that rate, but only be if the car was made in the last five years, I put down 25%, and I took a 48-month term. Unfortunately, the car was just outside the 5-year window, but the banker said a higher down payment might fix that. So I got the paperwork from the dealership and took it to the credit union.
I didn’t have an account at the credit union, so I signed up real quick and sat down with a banker. After the banker pulled my credit report, I got a very pleasant surprise: the 1.9% interest without having to put down any money. This wasn’t some crazy dealership “NO MONEY DOWN!” offer; this was a credit union that had no relationship with me giving me tens of thousands of dollars for four years at a 1.9% interest rate. All due to a credit score over 800!
Although I’d intended on paying off the car off early, the cogs and gears started cranking. It didn’t take long to realize that it was actually better to make the minimum monthly payments, and take the extra capital I’d planned to put toward the car, and invest it or put it into a retirement account where it almost certainly would grow more than 1.9%!
The bottom line is that a good credit score can open up new opportunities for you and result in you saving tens of thousands of dollars. Any time big money is involved, make sure to do your due diligence in figuring out the best way to take advantage of the processes and procedures involved.
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