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Americans are starting to wake up to the idea that if you have bad credit - or even so-so credit - it might prevent you from doing things you want to do, like buy a first house or refinance your mortgage.

As mortgage lenders increasingly use credit scores to decide who is credit worthy, improving, and then maintaining, your credit score has become one of the most important financial moves you can make.

But with the average American now carrying about $8,000 in credit card debt, bankruptcy rates have soared over the past couple of years. Unfortunately, filing for bankruptcy stays on your credit history for 10 years, and can significantly lower your credit score.

Kerri filed for bankruptcy in 1995. Her husband filed for bankruptcy in 1998. Today, her credit score is around 700 and her husband’s credit score hovers around 680.

Unfortunately, these scores aren’t good enough to qualify for the best interest rates and loan programs on the market, according to Fair Isaacs, the company that invented the FICO credit score used by approximately 70 percent of mortgage lenders.

If you have a credit score of 720 or higher, you’ll qualify for the best loan programs and interest rates. Kerri’s score of 700 falls into the second-best category, while her husband’s score of 680 just makes it into the third-best category.

The difference in categories has a profound effect on what interest rate you pay. According to myFICO.com, if the best credit score would qualify for a loan with an annual percentage rate (APR) of 5.91 percent, Kerri would qualify for a loan at 6.03 percent. But her husband would barely qualify for a 6.5 percent loan.

What does this mean in terms of their monthly payments? On a $200,000 loan, if Kerri and her husband qualified for a loan at 6.5 percent rather than 5.91 percent, they’d pay $100 more per month and $28,000 more in interest over the life of a 30-year loan.

That’s pretty costly, and the numbers only get worse as your credit score goes down. For example, if your credit score is just 620, instead of qualifying for the best rate of 5.91 percent, your loan will be at 7.72 percent. That means your monthly payment will be $250 higher and you’ll pay about $90,000 more in interest over the life of your 30-year mortgage.

The good news is that even if you have lousy credit, there is a lender who will loan you money to buy a house. Since interest rates are at 40-year lows (but are expected to rise later this year), the current interest rate available to those with poor credit is still less than 8 percent, which, historically, is a great interest rate.

Kerri’s other problem is that she and her husband have no savings to put down on a home. That means they’ll need 100 percent financing for their purchase.

While many first-time buyers lack cash for a down payment, it’s a pretty common scenario for someone who has recently emerged from bankruptcy.

Kerri has been offered a first mortgage for an 80 percent loan at 6 percent and a second mortgage at 10.5 percent. While that’s a bit higher than the going second mortgage rate (at press time), it’s not out of the ballpark, lenders say, especially for someone with her credit score.

But the scenario could get better for people like Kerri, even if interest rates do rise. Congress is currently considering legislation that would grant the Federal Housing Authority (FHA) the ability to do 100 percent financing.

Like regular FHA loans, these 100 percent loans would make it easier for Kerri and her husband, and thousands of other Americans to get over the double hump of not having the cash for a down payment and not having the best credit score.

While they wouldn’t necessarily be the cheapest loans on the block, they would be available to those whose credit score presents some challenges, or need to have a higher debt-to-income ratio in order to make the numbers work.

While some wonder if this legislation can be passed this year, others are more sanguine about its chances. After all, we’re in the middle of a presidential election cycle and homeowners (who tend to vote more often than renters, a fact not lost on our politicians) are often the beneficiaries of Congress’ largess.

By Ilyce R. Glink

This entry was posted on Friday, May 30th, 2008 at 7:59 am and is filed under FSBO. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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