"Take good care of your credit and your credit will take good care of you" could not be more true than when you are considering purchasing a home.
A homeowner wanting to refinance came to me recently to start the loan process. His current rate is at 5.5 percent and he was hoping to drop that rate down to 3.75 percent. On a $315,000 mortgage, that savings represents a drop of $5,500 per year. To calculate that savings in the first year, just multiply the loan amount $315,000 times 1.75 percent, which is the potential drop in interest rate. As the loan amount decreases, this savings will decrease. For example, after five years of payments, the loan balance will have dropped to $284,000 and the interest savings will have dropped to $4,970 for the year.
As a side note, calculating the effect of a refinance is more accurate when you take into account the savings in interest as opposed to comparing the new principal and interest payment with the old principal and interest payment due to the fact that merely extending the life of the new loan to 30 years will look like a savings when, in fact, it is just taking longer to pay off the loan, which would only represent an improvement in cash flow.
When first meeting with a homeowner who wants to refinance, I will first examine three main areas of the borrowers' financial situation: income, equity and credit history. In the above example, this homeowner had good income and adequate equity with the potential to
As it turned out, after having a perfect credit history and mortgage payment history for years, he missed a $29 monthly payment on one of his department store credit cards and that is the only thing that I saw that could have caused his credit score to drop 100 points in a month. It may not be fair but it is a clear example of how empirical the credit reporting formulas are. It would seem that the homeowner gets no creditability for all of the years of making payments on time.
Credit history will take care of itself over time but it could take months or more before his credit returns to a respectable level. One possible solution is to beg the credit department store to issue a letter stating that the late payment was an error. Once we have that letter, we can ask the credit bureaus to recalculate his credit scores.
If a collection account that, say, was placed on a borrower's credit report a year ago is paid off today, the borrower's credit score is likely to actually go down. The reason is because the collection account that was old and having less of an effect on a credit score now becomes current, even though it is now paid off, and that will current status will place downward pressure on credit scores.
I know it's not fair but it is better to hear these situations than to have them happen to you. Furthermore, a low credit score that does not eliminate a borrower from obtaining a loan approval can add up to $10,000 or more to the upfront fees. This is called risk-based pricing.
Local mortgage consultant Peter Boutell has been writing a weekly column for the Sentinel since 1995. Send questions to Lending a Hand,' 1535 Seabright Ave., Santa Cruz, CA 95062, fax them to 425-1044 or email them to email@example.com. Archived columns are available at www.peterboutell.com.