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How Much Is A Credit Rating Worth?
By Max | August 27, 2007
Yesterday, I was talking with a friend when I realized something. A credit rating has a value. I guess I never really thought about it before, I just had always assumed that I needed good credit.
We were talking about the current housing bubble, and how much home prices might drop in Phoenix where I live. There are a lot of people around here who have spent quite a bit on houses in the last couple years. If someone bought a $400,000 house with 100% financing and prices dropped by 25% (they’ve already dropped about 10% here), their house would be worth $100,000 less. Thats a substantial drop. The smart choice for a homeowner in this situation would be to just walk away. Even if the homeowner had a good job and good credit, and was still able to make the monthly payment, the smart choice is still just to walk away.
Why should person want to ruin their credit like that? Having a foreclosure in your past is a pretty big blemish. The reason depends on how much borrowing the homeowner plans on doing. Your credit rating is only worth the difference in interest payments you would have to make if your credit score dropped. Since after foreclosure, one can immediately begin rebuilding their credit, it would be rare that someone would save $100,000 by maintaining good credit. Since the homeowner already owns a house, there are very few opportunities besides starting a business that would offset the $100,000 lost by keeping the house.
This should be alarming to you. If everyone who bought a house in Phoenix with 100% financing in 2005 and 2006 was suddenly in this situation, many are just going to walk away. Its the smart thing to do. Subprime borrowers are just a small group compared to the potentially large group of homeowners who might just walk away. The results of something like this would be pretty dramatic.
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August 27th, 2007 at 1:27 pm
I don’t understand… why would prices dropping cause homeowners to have to go into foreclosure?
August 27th, 2007 at 2:20 pm
Supply and demand. When someone goes into foreclosure, the bank has to sell it. Few buyers are in the market right now, so the bank has to sell it for less money, so housing values fall. As housing values fall, more people will go into foreclosure. Its a vicious cycle.
August 27th, 2007 at 4:09 pm
I met with a realtor today but he wanted me to sign some agreement before he would send me any listings, so I have not yet done that.
August 27th, 2007 at 5:21 pm
Lindsay,
You don’t have to sign anything. Before you sign anything, we need to talk.
August 27th, 2007 at 8:35 pm
Lindsay:
You need to think twice about buying a house right now. Some smart people at Goldman Sachs are predicting a national 15% decline in housing. If that’s not convincing enough, an IMF report in 2003 found that 40% of housing booms were followed by housing crashes–that lasted 4 years (on average).
Owning a home is what most people in this country consider to be the American dream and the mantra goes that buying a house is smart because you’re not throwing money away on rent. Consider this–if you don’t put a large enough down payment on your house, in the beginning you will be paying more in interest than you would be ‘throwing away in rent.’ If that’s not bad enough, you also have to consider insurance and property taxes.
Certainly, the government gives lots of incentives (which are partially responsible for this mess in the first place). Weight the positives carefully against the negatives. It might just be that buying a house right now is a good option for you. It might not. Just be careful and make sure that it really is the right choice for you.
And pay close attention to any agreements put before you. People are having trouble selling houses right now and you have nothing but time in these deals. Realtors are hurting right now and I wouldn’t put it past any of these shysters to try and take you with superfluous fees. Don’t be afraid to take any agreement home with you to discuss with family or even a lawyer and take all the time you need before signing anything. You’re in charge–not them.
August 27th, 2007 at 8:50 pm
Matt,
Lindsay lives in Columbia, SC. There are few places in the country where real estate is cheaper. They were basically unaffected by the real estate boom, as prices have increased only modestly (<5%) over the last few years.
August 28th, 2007 at 7:11 am
A realtor asking you to sign something before you even get to SEE any listings?
Time to call someone else…
)
(Or use Craigslist
September 5th, 2007 at 10:57 pm
I think when real estate really tanks, we should buy some up. Eventually it will come back.