The Cost of Bad Credit | How FICO Scores Can Affect You

Learn About Credit 101:Lesson 4 of 4

When it comes to your credit score, if you aren’t making the appropriate financial decisions to keep it as high as possible, you are playing with fire that could cost you hundreds of thousands of dollars.

In recent times lenders have had to become more selective about who they loan to. As a result, the difference someone will pay with bad credit versus good credit is substantial. Lower scores can drastically change your financial situation your whole life.

I’ve created a scenario to contrast the situation between two women who make the same financial purchases and moves over the course of their life. They are teachers at the same school; they live in the same area, and have similar income and family. The only difference between the two women is their credit score.

Sally has a FICO credit score of 740 and Sara has a 620.

Sally maintains her good credit by:

• never maxing out her credit cards

• applying for credit sparingly

• paying her bills on time

Creditors value this type of borrowing and reward Sally by offering her more credit, increasing her credit limits, which permits her to spread her balances across several cards. Sally knows how important her credit score is and takes the necessary steps to protect it.

Alternatively, Sara’s poor credit is a result of:

• missing one semester of work unpaid because of a medical issue

• sometimes maxing out her cards

• sometimes doesn’t make her payments on time

This type of financial behavior discourages lenders to extend more credit. Sara tends to spread her balance across fewer cards than Sally resulting in a lower ability to negotiate lower interest rates.

Sally and Sara borrow the same amount of money over their lifetimes but spend different amounts because of their credit scores.

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Here is a scenario to help you understand how.

• Each obtains $20,000 in private student loans

• In college they get their first credit cards (age 20) that carry a $12,000 balance, on average, over the years

• They buy new cars (first car, age 20) and replace them every 5 years. They purchase their last vehicle at age 70.

• Each buys her first home with a mortgage of $200,000 at age 30

• They each move into a new larger home after turning 40 ($300,000)

• Their second home also has a $50,000 home improvement loan taken out for remodeling

**Please note that the following examples are purely hypothetical. Interest rates will rise and fall over time and payments on homes and cars will vary as a result of this. These illustrations are meant to help draw a picture of how much average to poor credit can cost someone. **

Private Student Loans: An almost $9000 difference

Federal Student loans can’t use your credit score as a factor. Private student loans can and do.

	Sally	Sara
Interest Rate	3.23%	6.80%
Monthly Payment	$276	$350
Total Interest Paid (10 yrs)	$8,075	$17,000
Sara’s Penalty		$8,925

**After reforms passed in the 2010 Student Aid Fiscal Responsibility Act interest rates are capped at 6.8%. Unfortunately, for people who have already graduated from college, the reform came too late.

Credit cards: $90 more a month

In the past couple years, credit card issuers have stiffened their lending standards, resulting in higher rates and pickier standards. Some even require a 720-750 to even be approved, regardless of the interest rate offered. It has gotten to the point where simply getting a credit card can be next to impossible if your score is under 675, according to Curtis Arnold of Cardratings.com.

	Sally	Sara
Interest Rate	11.99%	20.99%
Annual Interest Paid	$1,439	$2,519
Total Interest Paid (50 yrs)	$71,940	$125,940
Sara’s Penalty		$54,000

Auto loans: $6680 more per car

Yahoo Car Finance

Each car that they purchase is valued at $25,000. The numbers below are based on a new car purchase of $25,000’s every five years. The difference in the interest rates seriously increases the interest cost per loan.

	Sally	Sara
Interest Rate	3.75%	9.76%
Monthly Payment	$458	$528
Interest Cost per Loan	$2,480	$6,680
Total Interest Paid	$27,280	$73,480
Sara’s Penalty		$46,200

Mortgages: An extra $100k

Interest rates are very low right now. With poor credit scores, lenders may not approve the application at all. Although there are many factors that contribute to the interest rate offered, credit scores still take the lead. My FICO Loan Center

The cost of a lower score is still substantial!

Home 1: 30 year fixed-rate loan for $200,000 paid over 10 years:

	Sally	Sara
Interest Rate	3.25%	4.61%
Monthly Payment	$870	$1,027
Total Interest Paid (10 yrs)	$37,733	$56,573
Sara’s Penalty		$18,840

**Payments totaling $157 more a month for the same priced home

Home 2: 30 year fixed-rate loan for $300,000 over 30 years:

	Sally	Sara
Interest Rate	3.25%	4.61%
Monthly Payment	$1,305	$1,540
Total Interest Paid	$169,800	$254,400
Sara’s Penalty		$84,600

**Payments totaling $235 more a month for the same priced home

Home Equity Loan: $118 a month difference

Similar to car loans, this type of lending is very sensitive to the credit score. Sara’s ends up with an interest rate that is over 4 points higher than Sally for a 15-year loan for $50,000:

	Sally	Sara
Interest Rate	6.17%	10.81%
Monthly Payment	$442	$560
Interest cost per loan	$29,560	$50,800
Sara’s Penalty		$21,240

As a 30 year old with a mortgage, car payment, student loan, and credit card Sara is paying $420 more a month than Sally for the same amount borrowed. Over their lifetimes, Sara pays a shocking $233,805 more. The above estimates also don’t take into account the higher costs of insurance.

Most importantly, these costs can’t display the lifetime of struggling for money. More of Sara’s paycheck was given to lenders. She had less expendable income available between each paycheck possibly causing unnecessary financial stress.

If you ever wondered how some families always seem to be struggling while others in similar situations aren’t, the answer could and most likely is their credit.

You can find a more more examples below:

Automobile Financing:
If you are financing a car and have bad credit you will be paying thousands of dollars more due to excessive interest rates charged by the lender. Had your credit been restored prior to purchasing the car, that extra money would be in YOUR pocket, not the lenders. The extra interest is calculated into the car payment leaving you with a dramatically higher payment, one you and your family can probably not afford. One of the first things that our members often do once their credit is repaired is to refinance their automobile for a “fraction” of their current payment, or, buy twice the car at nearly the same payment…

Example: $25,000 car loan paid over 5 years:

Credit Status	Interest Rate	Monthly Payment	Extra Interest over 5 years
Excellent	5%	$471	$0
Fair	10%	$531	$3,564
Bad	16%	$608	$8170

Home Mortgage :
The “American Dream” of owning your home is out of reach for most people with credit problems. As you can see below, over time, even mildly damaged credit will cost a fortune in additional interest rates. This forces credit challenged consumers to raise their families in less desirable neighborhoods and pay off someone else’s mortgage! This leaves the credit challenged family holding year’s worth of rental receipts and nothing to show for it.

Example:$200,000 house mortgage paid over 30 years:

Credit Status	Interest Rate	Monthly Payment	Extra Interest over 5 years
Excellent	5%	$1,073	$0
Fair	8%	$1,467	$36,360
Bad	12%	$2,057	$59,040