The Consequences of Bad Credit - Bad Credit, Bad Interest Rates

Homeownership - it's the American Dream. Unfortunately, trying to get a mortgage loan can be an American Nightmare for people with bad credit. But once a person with bad credit finally finds a mortgage, the nightmare is far from over - it can last for up to 30 years in the form of higher interest rates and backbreaking mortgage payments.

What is Interest?

Interest is a payment designed to compensate a lender for risk. Since people with bad credit are considered to be greater credit risks than people who don't have bad credit, they are made to pay higher interest rates. It's simple - every lender looks at you the same way that Donald Trump looks at a business deal. He determines how likely it is that you will default on (fail to pay back) your loan, and then he decides how much, in interest, would make it worthwhile for him to take the risk of lending money to you. If you don't like the interest rate he offers you, then you are free to look elsewhere for a loan - but people with bad credit are often left without many options.

Good Credit vs. Bad Credit

Standard loan payments are made up of two components - interest and principal. For example, someone with good credit may be able to qualify for a 30-year mortgage loan for $100,000 at 5.89% APR (annual percentage rate of interest). This would result in monthly payments of about $592, a portion of which would be applied to the principal (paying down the loan), while a separate portion would be in interest. Mortgage loans are amortized over time, which means the portion of a monthly payment that is interest is greater at the beginning of the loan than it is at the end of the loan. This is because as the principal is paid down over time, there is less principal on which to charge interest. For example, the first monthly payment for a mortgagee (person with a mortgage loan) with a 30-year, $100,000 mortgage loan at 5.89% APR would be $592 - $491 of which would be interest, while only $101 would be principal. But fast forward 25 years, and the same monthly payment of $592 would be just $151 in interest, with the rest ($441) in principal.

How does this compare to a bad credit mortgage? Well, let's say someone with bad credit has to pay an 11% rate, as opposed to 5.89%. That would result in monthly payments of over $952 instead of $592 - a monthly difference of $360! The first monthly payment would apply only $35 to principal, and after one full year of paying $952 a month, less than $470 of the loan will have been paid down. Imagine paying $952 each month, over $11,000 in a year, and having your debt reduced by less than half of one payment! That's the cost of bad credit.

What You Can Do About It

Everybody needs a place to live, and often times, paying a bad credit mortgage is worth it to have the home of your dreams. After all, when you pay rent, 0% of your monthly payment is applied to principal. While bad credit mortgages are harder to come by, there are resources available for people with bad credit to own their own homes. Alternatively, you can take actions to begin improving your bad credit so that you can qualify for lower interest rates. This web site is a great place to begin that journey.

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