It is true bad credit can hinder your financial freedom as a consumer, but many do not realize the effect is often more holistic. Credit scores are dropping quickly all over the nation, and it is not good for the economy.
In particular, the real estate sector is being affected. Obviously, real estate depends on the ability to take out a long-term mortgage, but as credit scores drop, so does the ability to get a loan.
What constitutes bad credit?
A credit score indicates to creditors whether or not you are likely to pay back your debt. Every payment made to lenders, credit cards, utilities, rent and mortgages contribute to a credit score. Most lenders put credit scores into six categories.
- Great credit is anything above 700.
- Good credit ranges from 680 to 699.
- Average credit is anything from 620 to 679.
- Low credit hits between 580 to 619.
- Poor credit is a score of 500 to 579.
- Bad credit ranges from 300 to 499.
Anything below 680 makes getting a loan difficult. Oftentimes, lenders will dole out high interest rates and expensive fees to those with credit below 680, which is not good for the real estate economy.
The average American has a credit score of 682, but this is not the norm. Studies show 56% of Americans have subprime credit. This keeps them away from good interest rates that would encourage the purchase of real estate.
Mortgage lenders do not like bad credit
The most obvious impact of bad credit scores on real estate is lenders are less likely to hand out mortgages to those with bad credit. If they do offer a loan, it is done with high interest rates and fees that discourage people from taking the plunge.
Research from Bloomberg shows about 58% of mortgages in 2016 went to people with a credit score of 760 or higher and less than 10% of loans going to borrowers with a credit score between 620 and 659. The researchers said the market is more restrictive now than it has been in four decades.
Buying a home has never been more difficult for those with bad credit. It has created a stigma that discourages mortgage applications even more.
An article from Credit Repair on how to buy a home with bad credit says a poor credit history makes buying a home a more difficult process it "almost always creates complications. A low credit score means that you will be charged a much higher interest rate when you apply for a home loan." You could also be denied altogether.
Understandably, this has a negative effect on the market since lower credit scores mean fewer people are able to purchase homes. The number of people choosing to rent has grown remarkably as there are fewer qualified buyers. The real estate market is not recovering as quickly as it might have if more people had been able to take out a mortgage for a home.
Bad credit slows investments
In addition, investing as a whole takes a hit when it comes to bad credit. Real estate is a smart avenue for investors looking to diversify their portfolios, but it is hard to get started without a good credit score to guarantee a mortgage. People are slow to enter the investment world and do not gain as much success as they might have otherwise.
According to Investopedia, people who have limited funds feel they are at a disadvantage. In turn, this causes many such investors to invest aggressively to make up for lost time.
Having poor credit can actually act as an advantage in real estate investing, however, as it can help investors qualify for certain subsidized loans and can act as a motivating factor for the investment. Many people do not see it that way, however, and take risky ventures instead. Once those do not pan out, they are likely to drop out of investing altogether.
Debt as a whole hurts the real estate economy
It is true good credit is the key to getting a great loan, and debt is required for that. However, it has a negative effect on the economy as a whole.
According to the Heritage Foundation, current spending and debt are "dangerously high" in America. The foundation says research has found advanced economies like the U.S. are at risk of significant reductions in economic growth when public debt reaches 90% of gross domestic product because it could drive up interest rates, crowd out private investment and raise price inflation.
In short, debt is making it difficult for people to buy homes. More than three-quarters of people who went to college are paying back student loans, and 69% of those said they do not feel financially secure enough to purchase a home. Credit card debt, car loans and other personal debts make it difficult for individuals to afford a down payment. All in all, the real estate investment outlook is not at its best.
Debt and poor credit scores continue to leave a negative mark on the economy. There are many solutions to this problem, but the most profound is on the individual level. As people work on improving their credit scores and ease their debt burdens, we can begin pouring more stable capital into real estate and help it stay stable enough to avoid another recession.
