A credit score indicates to the lender
the likelihood of a loan being repaid. The higher the FICO score, the more
likely a loan will be repaid. Often times, those with low scores are offered a
higher (AKA sub-prime) rate for car, home, and other credit purchases. It would
not be unusual for someone with a low rating to be offered a 10-14% or higher
interest rate on a used car loan when the prevailing rates for someone with a
good credit rating would be about 7% or less. That was prior to the recent recession.
Lenders are much more conscious of the defaults in subprime loans that have
occurred over the past 5 years. Many have stepped away from the subprime market
completely. Thus, for many lenders, either you qualify for a loan or you don’t.
The subprime loan is no longer an option for many traditional lenders or many
borrowers.
There are still some institutions that
will lend to people with slightly less than perfect credit; they are known as
credit unions. Why? Because credit unions take a more holistic approach to
lending to their members. The FICO Score is important, but is not the only
factor considered when lending. A credit union may require a higher down payment
of subprime borrowers and/or ask them to pay a slightly higher interest rate.
They will look at the applicant’s employment; how long have they worked for the
same company? How long have they lived in the same home or neighborhood? How
has the member managed their credit over the past 24 months? The answers to
these questions may increase or decrease the interest rate or down payment.
As an example, let’s say a FICO score of
equal to or greater than 740 is the target score for the institution and someone
in that score range will get a rate of 2.99% for a new car loan with zero down.
In this case, if someone misses the target by a bit, say the member comes in at
680, the credit union would likely make the loan with a somewhat higher rate
than the base rate to help the member. Instead of 2.99%, perhaps the loan would
be for 5.50%.
In this case, a car loan of $15,000
applied for a borrower with a 740 score and a borrower with a 680 score, there
is a 2.51% difference in the loan rate (2.99% APR vs. 5.50% APR). The borrower
with the 740 score will pay only $934 in interest over a 4 year period where
the borrower with the lower score might pay as much as $1,745; a difference of
$811 over the four year loan term. The borrower may not only be required to pay
a higher interest rate, they may have to come up with money for an additional
down payment. Subprime borrowers are often called upon to have a higher equity
in their security than those with preferred rates. That is an additional cost
to the subprime borrower. That is money that has to come out of savings leaving
the borrower with reduced liquidity. Another cost is the loss of earned
interest on the money used for the down payment. Let’s say the borrower has to
put up an additional $3,000 in order to qualify for the loan, $3,000 in a
savings account at 1% APY for 4 years would have earned $125. That’s better
than spending an additional $800 in interest expenses.
Avoid these increased costs by managing
your credit correctly.
- Pay your bills on time and pay more than the minimum when possible.
- Pay down outstanding balances.
- Avoid using your entire credit available limit
- Only apply for credit when you want it. Don’t apply for a card just to get a discount!
- Read your credit contracts. Don’t get caught in a consumer trap.
* * *
Are you planning on buying a home? This is one of the great times to purchase one. Loan rates are low and home prices are starting to rise! If you are ready to buy, visit our next Homebuyer's Seminar here at the Meriwest Credit Union main office on Sept. 8th. Get all the details you need to finance your home purchase! Curious about rates? Here are some links to our current interest rates on consumer and home loans:
Auto Loans - New and Used
Home Loans
Equity Lines of Credit
No comments:
Post a Comment