They are the worst. They never made sense to me. Hey this person's credit sucks, let's make it harder for them to pay back this loan.
Discussion
it’s awful and historically racist.
i’m working on mine right now so i can buy a house, and it’s been so hard.
Do you have no credit or bad credit? If no credit and you live in the US then research/consider/ask about an FHA mortgage. It’s backed by the big gov and you pay more but it’s doable.
The idea is not about making it harder for someone who is less creditworthy to pay back a loan, though that is the end effect.
The point is that the person with a low score is a higher risk to the lender that they may default. The higher rate is to provide:
1. A disincentive to the higher risk borrower, so that they are less likely to accept the terms of the loan, resulting in less risky loans on the books.
2. A higher compensation to the lender for taking on a higher risk, which also makes it more likely that if the borrower does default at some point in the middle of the loan term the lender has at least received payment equal to the original principal of the loan.
3. An incentive to the lender to be willing to lend to riskier borrowers at all, since most lenders still won't make loans to folks below a certain score threshold, because they simply present too much risk of default.