Credit Scores and Wealth Building: The Key to Financial Success
Your credit score is one of the most important factors to consider when it comes to managing your finances. It is a numerical representation of your credit history, serving as a snapshot of your creditworthiness. Lenders, insurance companies, landlords, and other financial institutions use your credit score to evaluate your risk level and determine whether or not to approve you for their offerings.
Simply put, your credit score is a reflection of your financial character. A high credit score signifies that you are responsible with your finances and are likely to repay your debts on time. This results in lower interest rates, higher credit limits, and more favorable terms on loans and credit cards. Conversely, a low credit score can make it difficult to obtain credit or result in higher interest rates and less favorable terms.
When it comes to mortgages, approximately 62% of homes occupied by their owners had a mortgage in 2020, according to a Construction Coverage study of US Census Bureau data. This underscores the prevalence of relying on mortgages for home purchases. While numerous factors shape the interest rate of a mortgage, your credit score ranks among the most significant. Therefore, your credit score greatly influences your financial management and mortgage options.
Credit scores influence so many aspects of your personal cash flow and cost of funds
How Much Does Credit Score Impact Interest Rate?
Every borrower’s situation is different, but it is not uncommon for borrowers to save tens of thousands of dollars over the lifetime of their loan by improving their credit score by 20 points. MyFico has a loan savings calculator that estimates how much a borrower could save on a mortgage based on their credit score. For example, assuming a 30-year fixed mortgage with a principal amount of $250,000, a borrower with a 650 credit score would pay almost $30,000 more than someone with a 670 credit score over the lifetime of the loan.
| FICO Score | APR* | Monthly Payment | Total Interest Paid |
|---|---|---|---|
| 760-850 | 6.751 % | $1,622 | $333,798 |
| 700-759 | 6.973 % | $1,659 | $347,141 |
| 680-699 | 7.150 % | $1,689 | $357,866 |
| 660-679 | 7.364 % | $1,725 | $370,933 |
| 640-659 | 7.794 % | $1,799 | $397,510 |
| 620-639 | 8.340 % | $1,894 | $431,843 |
*APRs as of August. 31, 2023. Source: myFICO
The MyFICO calculator is not designed to show rates for people with credit scores below 620. However, bad credit mortgages do exist for people with credit scores less than 620. It shouldn’t be a surprise, but bad credit mortgages come with even higher interest rates, making them more expensive over the lifetime of the loan. For those with bad credit scores, an alternative path to homeownership is to consider rent-to-own homes. This option allows aspiring homeowners to get into the home of their choice and provides time to improve their credit and build up their down payment before having to buy the home.
Building wealth to last as long as the redwoods takes planning, like the trees it needs to be nurtured.
Does a Low Interest Rate Mortgage Lead to Wealth?
Historically, homeownership is considered a good pathway to building wealth through appreciation, an inherent savings mechanism, and host of other benefits. In addition, a home can be passed onto future generations, which leads to generational wealth. To truly amass wealth , the home’s appreciation should exceed the mortgage interest paid. Hence, a favorable credit for an affordable mortgage is crucial. In addition, the money saved with a lower interest rate mortgage can be used for other investments and to build up a safety net.
Suze Orman, a respected financial expert and educator, mentioned “the key to making money is to stay invested.” Essentially, Suze is saying that to build wealth one has to be patient and think long term. In real estate, this means holding and maintaining the home for the long haul. Furthermore, improving your credit score is not an overnight process, but with persistence and consistency, individuals can take significant steps towards securing their financial future.
For those with a poor credit score, it is crucial to put together and follow through on a plan to improve your credit score, as your credit score has an outsized influence on your financial health. For instance, paying bills on time and lowering your credit utilization ratios account for almost two-thirds of a person’s credit score. While credit score is an essential factor in obtaining a mortgage, it is not the only factor that lenders consider when determining eligibility and interest rates. Other critical factors include the borrower’s income, debt-to-income ratio, down payment, and additional lender criteria. Therefore, when shopping for a mortgage, it is crucial to consider all of these factors to ensure that you make the best financial decision.
As a reminder, your credit score is a pivotal factor that influences your financial journey and prospects for building wealth. Its impact on interest rates can save you substantial sums over time and potentially shape your ability to achieve significant financial goals, such as homeownership. Whether you’re starting off in life or striving for homeownership, nurturing a healthy credit score is an essential endeavor.
Blue home image courtesy of macrovector on Freepik
