What Bad Credit Costs
The Cost of Bad Credit: Is Your Score a Negative Draw on Your Bank Account?
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If your score is below 600, it might be considered bad credit. Many people think the only reason to have a strong credit score is so they can get approved for loans and credit cards. While it is true that a good credit score improves your chances at approval, it is also true that you can get a loan with bad credit—it is usually more expensive though. Find out more about the cost of bad credit below and what you can do so you do not have to pay a higher price for it.
What Is Bad Credit?
Bad credit means your credit score is on the lower end of a scoring model. A variety of scoring models exist, but the most popular are FICO and VantageScore. Both models scores range from 300 to 850.
On the FICO Score model, 300 to 579 is considered very poor and 580 to 669 is considered fair. On the VantageScore model, 300 to 499 is considered very poor, 500 to 600 is considered poor, and a score of 601 to 660 is considered fair.
Why Is It Important to Have Good Credit?
Good credit is important for a number of reasons. First, you have a better chance at getting approved for any type of credit if your score is higher. Second, a better credit score can lead to more favorable interest rates and terms, and that can make your debt less expensive overall. Third, good credit makes you a valuable customer, which means banks, credit card companies and other institutions might be more likely to make special offers or provide rewards.
Good credit is desirable because it demonstrates that you are most likely a responsible account holder. Your credit score is based on factors that include your payment history, credit utilization, and the types of credit you manage and how long you have had credit.
Payment history accounts for 35 percent of your score and is the most important factor. If you have a good or excellent score, there is a good chance you are someone who pays their bills on time and as agreed, and that makes you an attractive customer for lenders.
How Bad Credit Can Cost You
What is the cost of bad credit exactly? It is much more than some lost opportunities. Check out the categories below to see how much bad credit could cost someone in each instance.
Your credit score plays a role in whether or not you are approved for a loan to begin with and how much you can borrow. A low score may mean you are limited when it comes to vehicle purchases.
The interest rate on your loan is also heavily influenced by your credit score. Borrowers with higher scores get better rates in general because they are considered less risky. If you have bad credit, the bank sees you as a risk and tries to hedge against that risk by charging a higher interest rate.
If you take out a loan on a car for $25,000 for 60 months with an interest rate of 3.11%, you’ll pay $27,026 total for the loan and make monthly payments around $450. That is an example of a loan you might get if you have decent credit.
The same loan at 9% interest has you paying $519 a month and $31,138 total. A lower credit score in this case could cost you more than $4,000 beyond the purchase price of the vehicle.
It is not just your monthly car payment that might go up if you have bad credit—you might pay more for your auto insurance too. That is because vehicle insurance companies see credit scores as a reliable way to predict the likelihood that you might make insurance claims.
Some states do not allow insurance companies to consider credit scores when pricing premiums, or they limit how insurance companies can use this information. But unless you live in one of these few states, which include California, Massachusetts, Utah, Hawaii, Oregon and Georgia, you may find your car insurance is more expensive if your credit score is low.
A low credit score may mean you can’t get a approved for a mortgage at all. For a conventional loan, you typically need a score of around 640. For government-insured mortgages, such as FHA loans, you might be able to get approved with a score of 580 or even lower.
Lower scores might mean that lenders require greater down payments or that you are limited on how much home you can afford. Lenders might also only agree to finance a certain percentage of the value of the home. By doing so, they help increase the likelihood the home will have equity, which makes it easier for them to recoup losses if you do not pay the mortgage and they have to foreclose.
As with car loans, your credit score also impacts your mortgage interest rate. Since mortgages are typically for many years, a higher interest rate can mean a much larger expense. For example:
- A mortgage for $250,000 for 30 years at a rate of 3.92% has monthly payments of $1,182. The total amount paid on the loan over 30 years is $425,533.
- The same mortgage at just 1% more—a rate of 4.92%— has monthly payments of $1,330 and a total amount paid of $478,749. Just a percentage point can cost you more than $50,000 on the total cost of the home.
Credit card debt essentially carries the same costs as car or mortgage loans. Lower credit can lead to higher interest rates and that can mean more expensive debt over time. According to Business Insider, the average credit card rate in 2020 is around 15.09%. But the average rate for someone with a credit score lower than 579 is 21%.
If you have a credit card balance of $1,000 at 15.09% and make minimum monthly payments of $40 on it, you’ll pay $1,208 total to settle the debt. At 21% interest, you will pay $1,326 to settle the debt in the same scenario.
But it is not just that your credit card debt might be more expensive. A lower credit score can lead to other costs too, such as needing to pay an annual fee or not gaining access to premium reward opportunities.
Renting an Apartment
Landlords are legally allowed to check the credit of prospective tenants and use that information to decide if they will offer a lease. Information in your credit report or your score might also be used to determine how much your rent will be or whether you must pay first and last months’ rent or a larger security deposit. But keep in mind that potential landlords cannot check your credit without getting written permission from you.
Some employers might check your credit as part of a background check when considering you for a job. If your credit score is very low or your credit report has negative items on it, you might lose out on the job opportunity. This can be especially true for jobs that deal closely with money or finances.
What Can You Do About Bad Credit?
If you have lost out on an opportunity or paid extra for something because your credit score is low, you don’t have to keep dealing with such losses. You can take positive action to help move a bad credit score in the right direction.
Check Your Credit Reports
First, get a copy of your credit reports. You can get your reports free at AnnualCreditReport.com. Usually, you can get one free credit report from each of the three major bureaus once a year. But because of the financial strain of COVID-19, you can get your free credit report weekly through April 2021.
Reviewing your current credit reports lets you know exactly where you stand. It also helps you identify areas that you might work on.
Try to Repair Your Credit
Once you know where you are, take steps to repair your credit so you can move in a more positive direction. You can engage in DIY credit repair by writing dispute letters for information you do not think is accurate on your reports. You can also work to improve in one of the areas that impacts your score, such as consistently making payments on time.
You can also work with a professional credit repair service. While DIY credit repair is certainly an option, professional services can provide personalized advice about how to improve your score. Credit repair specialists also work aggressively on your behalf to dispute and follow up on inaccurate negative items that might be bringing your score down.
Make Good Decisions in the Future
Continue to make good decisions and manage finances responsibly in the future. Pay all your bills on time, do not run up high debt balances on credit cards and other accounts and ensure you have a diverse credit mix. Creditors like to see that you can manage both revolving and installment accounts responsibly.
For more information about the cost of bad credit and what might be negatively affecting your credit score, contact the credit repair consultants at Lexington Law.