Should Mortgage Borrowers With Poor Credit Shop?
October 25, 1999
"You keep saying that home buyers ought to shop for the best mortgage terms, but suppose your credit rating sucks? Won't I have trouble finding a lender who will even deal with me, let along find a lot of them who will compete for my business? The one mortgage broker I spoke to said he might be able to find me a loan but that it would be a lot of work on his part, and there was a clear intimation that he wouldn't be bothered if I went to other brokers. How should I deal with this situation?"
From a mortgage broker's point of view, the best customers are those who place themselves wholly in the broker's hands, without shopping other sources. Hence, what the broker told you was self-serving. It might or might not be true.
There are three major factors that determine whether loan applicants with poor credit can profit by shopping. The first is the size of the loan they are looking for. Brokers make most of their money by charging points, which are expressed as a percent of the loan amount. A one-point charge on a $200,000 is $2,000 whereas the same charge on a $50,000 loan is only $500. Since brokers can make more on large loans, they are more willing to compete to get the loan, and to struggle with lenders to gain an approval.
The second factor is just how bad the applicant's credit is. Many people have expectations about their credit that are way off base. I had a letter from a consumer recently who dreaded getting a credit report because three years earlier she was late one time in paying a gas bill. In contrast to her expectations, her rating was very high. It works the other way too. Many consumers harbor the notion that their late payments haven't hurt them because they paid eventually, which is not the case.
You can get at least a rough idea of how good or bad your credit is from several internet sites that provide this as a free feature. A few of them are: www.mortgagequotes.com, www.mortgageit.com, and www.quickenmortgage.com.
The third thing you need to assess is your financial status, relative to the amount you plan to spend on a house. For this purpose, use my affordability calculator. It will show you, for different sale prices, the minimum cash, minimum income, and maximum debt to qualify, disregarding your credit. If your credit is poor, your financial position must be correspondingly stronger. Having income that is above the minimum is good, but having more cash is even better. A large down payment is the most effective way to neutralize bad credit.
If you are looking for a small loan (say, below $100,000), and if your credit rating is poor and your financial status marginal, then your best course may be to place yourself in the broker's hands. This makes you completely vulnerable, so you should say a little prayer that your broker is one of the good guys rather than one of the predators.
In all other circumstances, you should shop. Indeed, it is more important for poor-credit borrowers to shop than it is for strong-credit borrowers because the gains from shopping are greater. To illustrate this point, on October 7 of this year, I shopped for a $200,000 30-year fixed-rate loan at zero points in California. For this purpose I used www.microsurf.com, a mortgage referral site that provides quotes for borrowers with credit ratings ranging from A to D.
The results are striking. The difference between the rate quoted by the highest and lowest-rate lenders ranged from 0.625% on loans to A borrowers to 4.75% on loans to D borrowers! Indeed, a D borrower who shopped could do better than a B borrower who didn't!
| Borrower Rating | Lowest Rate | Highest Rate | Spread |
| A | 7.875% | 8.50% | 0.625% |
| B | 8.99 | 11.62 | 1.63 |
| C | 9.50 | 12.00 | 2.50 |
| D | 10.25 | 15.00 | 4.75 |
Borrowers with poor credit are thus more vulnerable to being duped because the market in which they operate is less efficient. And a major reason the market is less efficient is that borrowers with poor credit are more reluctant to shop.