Credit scores, down payments, and mortgage interest rates ?
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?
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.
P.S. Thinking about getting a new mortgage or refinancing an existing
one? Join the Interest Rate Investigator Newsgroup to determine if you
should lock or float with the Daily Mortgage Interest Rate Watch.
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.asp
My 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.
FACTS:
- 1 discount point equals 1% of the loan amount.
- Buying one discount point doesn't mean you will receive a 1%
reduction in interest rates
- Most less then perfect loans are based upon adjustable rate terms.
RESULTS: You have spent thousands of dollars to buydown the interest
rate to a close to prime level; I have spent nothing.
Phase 2
YOUR THEORY: Keep the less then perfect credit loan
MY THEORY: Refinance out to a prime rate mortgage (assuming credit
improvement) and invest in discount points to buy down your permanent
loan.
FACTS:
a. A majority of less then perfect loans adjust on the 2nd or 3rd
year.
b. A majority of less then perfect loans are based upon the 6 month
LIBOR index; that means the loan will adjust twice a year after the
initial fixed period has expired.
c. The usual adjustment caps for a 6M LIBOR indexed loan is 1%; that
means your interest rates could go up as high as 1% every 6 months.
d. The usual lifetime cap for a 6M LIBOR indexed loan is between 6-7%
higher then the starting rate; that means that one could expect to
reach the lifetime cap before retiring the loan (particularly in the
upwardly trending interest rate enviroment that currently exists).
Based upon the range (9-13), one could expect their interest rates to
be 15-19% once lifetime cap levels have been reached.
RESULTS: You have invested alot of money (in the way of discount
points) in a loan that has a high probability for upward rate
adjustment; I invest to purchase down the interest rates on my
permanent loan. You will most likely need to refinance your loan once
the rate adjustments have peaked; I will never need to refinance again.
You will need to reinvest in discount points, closing costs, escrows
and prepaids and in essense invest twice; I invest only in permanent
financing, not the "bridge" loan.
This is a little more then theory; I call it long term planning.