I often hear people say that buying a house is the best tool for building wealth. Is that really true? That depends on many factors. In this blog I look at how credit score will impact that conclusion. Some people are really unsure of what credit score means. While you may hear a number like, 620 or 729, how does credit rating affect your house in building wealth, especially retirement wealth?
Cost to own versus house price
When buying a house many people focus on the selling price. In some instances, you may be able to negotiate the price. That depends on whether or not you are in a desirable location and in whether you are buying during a sellers’ or buyers’ market environment. Just because you may be buying in a buyers’ market you may find yourself needing to sell in a sellers’ market.
Credit ratings and buying a house on credit
Most people need to use a mortgage in order to acquire a house. At closing, you promise to pay not only the actual selling price of the house but also any interest payments due the lender. You may have been led to believe that those interest payments are deductible. It’s understandable that when you hear deductible it sounds like complete deduction. In your insurance deductible, it is a dollar for dollar reduction. When you have a bad meal and the entrée is deducted it is a dollar for dollar reduction. Not so with your interest payments.
Unfortunately, they are not deductible as a complete subtraction from your taxes due, but rather, they could be a deduction from your income, of which your income taxes due are primarily based.. As the details of tax are beyond the scope of this blog, I recommend that you ask your tax professional to explain the terms above the line deduction, below the line deduction and tax credits. In the language of the IRS deductions and credits are not the same thing.
Small mortgage percentages multiply to big dollars
I found a handy calculator at MyFico.com. It showed the difference in interest rates based on the state of Illinois and various credit score ranges for a 30-year fixed mortgage. Here’s what I found for a loan value of $300,0001:
| Difference | 760-850 | ||
| 760-850 | 3.149% | ||
| 700-759 | 3.372% | 0.223% | |
| 680-699 | 3.550% | 0.178% | |
| 660-679 | 3.765% | 0.215% | |
| 640-659 | 4.197% | 0.432% | |
| 620-639 | 4.746% | 0.549% | 1.60% |
The difference between 850 and 700 was less than 1/4 percentage point. The difference between 760 and 620 was 1.6%. At first blush these numbers don’t seem to be so large. However, let’s look at the principal and interest for this $300,000 when that rate compounds over 30 years:
| Monthly2 | Difference | Annualized | |
| 760-850 | $1,289 | ||
| 700-759 | $1,326 | $37 | 444 |
| 620-639 | $1,564 | $275 | $3,300 |
Examining the highest two credit bands you see a $37 difference which annualized is to only $444. When you compare the highest band in the lowest band the difference widens to $275 (annualized $3300). That that is more than half the current maximum Roth IRA contribution limit. Over 30 years, that is $99,062 that could be contributed to retirement savings, before any potential growth from investing the money. By the way, that money would be more readily available to use (liquid) versus being stuck in your house (illiquid).
| Total Interest | Difference | |
| 760-850 | $164,057 | |
| 700-759 | $177,285 | $13,228 |
| 620-639 | $263,119 | $99,062 |
When you look at these numbers over the lifetime of the loan, the person within the 620 – 639 credit rating band pays almost $100,000 more than the people in the 760-850 credit rating to own the same house. When you add the cost of the house, $300,000 to the total interest, $263,119, you would need to sell the house for $563,119 for a breakeven of total cost. The person with the 760-850 credit rating would only need $464,057 to break-even. Are there guarantees on what anyone will be able to sell their house for 30 years from now? An old adage in real estate is “location, location, location”. There is no way to know if you will have the right location in 30 years.
Consider the following hypothetical example. You take that annualized savings of $3300 and get a 6% rate of return over the 30-year mortgage term. In that case $99,000 that would’ve gone to interest payments turns in to about $275,000 in liquid money in your Roth IRA account.
Your house and overall investment portfolio
If you did combine buying the house and were able to invest any money from mortgage interest savings, your assets overall would at least be more diversified. If the housing market were down and you couldn’t pull much money from your house in a sale, you would have a separate account to draw from. If the stock and bond markets were down and the housing market was up, you could access money locked in the house through a sale or possible equity. As facts and circumstances may not apply to you, please Contact Us to discuss things further. Early adjustments to retirement planning assumptions typically are smaller than ones that come later.
1The rates shown are averages based on thousands of financial lenders, conducted daily by Informa Research Services, Inc. The 30-year fixed home mortgage APRs are estimated based on the following assumptions. FICO scores between 620 and 850 (500 and 619) assume a Loan Amount of $150,000, 1.0 (0.0) Points, a Single Family – Owner Occupied Property Type and an 80% (60-80%) Loan-to-Value Ratio.
2Monthly principal and interest
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
