When you were 13 or 14 years old you probably dreamed of owing a car. Having a car meant freedom — cruising with your friends, hitting the open road or just being able to come and go pretty much as you pleased. You may have even been able to picture your dream car.
Now that you’re an adult and if you’re typical your biggest dream now is homeownership. The idea of owning your own home has become such an ingrained part of American society that it’s often referred to as the American dream. Homeownership comes with some of the same perks as having your own car. It’s a form of freedom in that you’d no longer be at the mercy of a landlord. It also means security because no one can kick you out of your own home – assuming you continue to make your mortgage payments. Owning your own home puts you in charge. No one can tell you that you can’t paint your kitchen or whether you can rip up that old, dingy shag carpeting. The decision is yours to make and yours along.
When you rent its kind of like pouring money down the drain. You pay your rent each month in return for which you get to stay in the house or apartment but you get nothing else in return. In comparison, every time you make a mortgage payment you build equity, meaning that you literally own more of your home. In addition, that house is most likely to increase in value over the years, which is why a mortgage is often called “good debt”. Most homeowners are able to write off the interest they pay on their mortgage which is yet another benefit of home ownership versus renting.
What’s your credit score?
We hope you already know your credit score because that little three-digit number is about to become critical. The most widely used credit scores are those generated by FICO. They range from a low of 300 to a high of 850. Most lenders view credit scores in ranges as follows:
Excellent Credit: 781 – 850
Good Credit: 661-780
Fair Credit: 601-660
Poor Credit: 501-600
Bad Credit: below 500
Here’s the problem in today’s mortgage marketplace. According to the Federal Reserve Bank of New York’s consumer credit panel about 50% of the $389 billion in mortgages went to people that had an Equifax Risk Score of 760 or higher. Equifax scores are a bit different then FICA scores in that they range from 280 to 850. If you count the number of loans that were given, rather than dollars, then 51% of the mortgages went to people with the Risk Score of 780 or higher.
What happened to the others
According to this same consumer credit panel, borrowers who had a credit score ranging from 620 to 659 received just 4.6% of the dollar volume of mortgages granted in that quarter. If you compare this with the same quarter in 2004 the 760-or-higher group received 23% of the mortgages and those with credit scores of 620 to 659 received 9.7%. In other words, since 2004 the number of borrowers with below-prime credit that got mortgages decreased by nearly 50%.
Too risk adverse?
As noted above, many middle-income families use homeownership as a way to build equity. However, in the first quarter of this year Black homeownership rates fell 41.5%, which was the lowest since 1995 and the rates for Americans overall have been below 64% for the past five quarters. All of this data raises questions about whether banks and regulators have become too risk adverse. The company CoreLogic, which provides property data, has reported that mortgage applications from borrowers with credit scores below 640 fell to 6% last year from 29% just 10 years ago. In other words, people with low credit scores aren’t even applying for mortgages.
What this means to you
The sad fact is that if you have a credit score of less than 680 you can just about kiss that dream of home ownership goodbye as it’s unlikely you’ll be able to get a mortgage – at least not until you do something about your credit score. Unfortunately, what you can do is very limited. No one knows exactly what formulas FICO or Equifax use to calculate credit scores but what is known is that your score is based on five components. They are:
Payment history: 35%
Debt amounts: 30%
Length of credit history: 15%
Credit mix: 10%
New credit: 10%
Unfortunately, there is nothing you can do about your payment history nor can you do anything about your length of credit history. The one area where you could do something that would improve your low credit score is your debt amounts, which is a shorthand way of saying the amount of debt you have versus the total amount of credit you have available. This is sometimes called the debt-to-credit ratio and is calculated by dividing your total credit into the amount you’ve used. For example, if you have $20,000 in total credit and had used up $10,000, your debt-to-credit ratio would be 50% or much too high. If you calculate your ratio and find that it’s above 30% this is an area where you could improve your score, simply by paying down some of your debt – until your ratio falls below 30%.
If you’d like to know the fastest way to improve your debt-to-credit ratio fast just watch this video.
A second area where you could do something to improve your low credit score is in your Credit mix or the different types of credit you have. If you have several credit cards, two or more other revolving lines of credit and, say, an auto loan that would be a good Credit mix. On the other hand, if you have just a couple of credit cards you might think of applying for some other different forms of credit to improve your Mix but, of course, you will need to be very careful as to how you use that new credit so that you don’t damage your debt-to-credit ratio.
Keep working on that low credit score
If you do have a low credit score but still harbor that American dream of owning your own home, you’ll just have to keep working to Increase your credit score. It will take time and may not be easy but the payoff at the end will be pretty terrific – fulfilling that American dream of owning your own home.
