I wasn’t planning on writing another blog post until next
week, however, Shaina and myself were talking about how policies in the
financial world today are set against those who are debt free. The specific topic being discussed was mortgage lenders and how they use the all powerful credit score to pretty much
determine your future when it comes to buying a home. Bare with me, I just feel
like ranting for a little bit.
After we pay off debt our next main goal is home ownership.
In doing a little research on loan types, programs, down payment requirements,
and so on, there’s one point that pretty much every lender takes into
consideration, and that’s your credit score. In my opinion the credit score is
one of the most backwards and flawed systems we have. Essentially your credit
score is a numerical depiction of how you interact with debt. If there is a lot
of interaction, meaning, that you a) have debt and b) make payments towards the
debt, you will most likely have a higher score. Inversely, if there is no
interaction, because you a) have no debt or b) you don’t make payments towards
the debt, you will mostly likely have a lower credit score.
Now, does any of what I just said throw up a red flag?
That’s right. If you have no debt, you
will have a low credit score. Have no debt for long enough, and you will have
no credit score at all. Obviously if you have debt and you stop making payments
you’re probably deserving of the low score. But that’s not the part I have an
issue with. Let me explain why I think this is a totally backwards system.
Mortgage lenders often use your credit score to assess risk.
In other words they look at your score, see that you have interacted with, or
made timely payments towards, some form of debt. They conclude that since
history shows you made payments on other debts, the chances of you continuing
to make payments are high, while the chance of you defaulting, or not making
payments, on your home loan is considered low. Lenders will value that risk and
will present you with an interest rate on your loan to compensate them for
taking on whatever risk they feel you impose. The higher the risk, the higher
the interest rate will be. For those who are declined, this usually this means
that the lender has determined your risk to be too high. Now, there are
obviously other factors that come into account such as debt to income ratios
and so forth. However, credit scores are a major driver.
Let’s look now at someone who has no debt, but who also may
have a very low or even now existent credit score. There are some lenders who are all "bad" and will look at this, take into account that the score is due to no debt, and will
move on to accepting other forms of validating payment histories such as
statements from landlords on rents paid, or letters from utility companies
showing timely payments. However, you may have to search a while before finding
a lender who will work with you like this. In fact a lot of the major banks will probably
look at you funny if you ask them that. As an example, after Shaina and I got
married we went to open a joint checking account at the bank we both had
previously banked at. During this process they asked us if buying a home was in
our future. I assumed this was a sales pitch and was right. We said yes, but
that it was still a few years out. But then the banker stated that at this
particular bank, they like to see at least five lines of credit open and active
to be considered for a home loan. Five! I really wanted to just laugh at him,
but of course my mother didn't raise me that way.
So let’s recap: More debt = higher score, granted that the
payments are made on time. No debt = lower score. In the eyes of the lender: higher
score = less risk of the borrower defaulting; lower score = more risk of the
borrower defaulting. I’ll let you make the decision on this for yourself, but
who do you think is at more risk of defaulting on their debt, including the new
home loan they just took on, say if they lost their job? Or in other words, who
has the better chance of paying back the money the home owner borrowed? The
perfect credit score who has a ton of debt with cash tied up in other minimum
payments, or the low credit score with no debt, no financial obligations to
anyone else, and who also has a history of PAYING OFF DEBT? Tough one, right?
Not really, but apparently our society can’t seem to fathom the idea that
anyone could survive without a credit score.
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