The True Cost of Bad Credit

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A drop in your credit score means more than paying higher interest rates for loans. It's actually much worse than that.

Your credit is super important to your overall financial health for at least three reasons.

First, bad credit means you pay higher interest rates when you borrow. Second, it can impact other expenses, like your car insurance: Insurers have figured out that people who wreck their credit are also more likely to wreck their cars. And, finally, it can hurt your ability to find work: Many employers also believe that those who aren’t responsible with their money might not be responsible with the boss’s either.

Is this fair? It’s debatable. But like it or not, it’s a fact. So it quite literally pays to keep track of your credit and keep it in the best possible shape.

One way to get an instant summary of your credit is by looking at your credit score. The company that produces the most-used credit score, the FICO score, is Fair Isaac Corp. You can use Fair Isaac’s Free Credit Scores Estimator to get an idea of how badly various mistakes in your use of credit can affect your score.

This post on the myFICO site forum discloses how many “damage points” can be subtracted from a consumer’s credit score for five credit mistakes. They are:

30-days late: 60-110 points

Debt settlement: 45-125 points

Foreclosure: 85-160 points

Bankruptcy: 130-240 points

Maxed-out card: 10-45 points

The higher end of the ranges above apply to consumers with higher starting scores (780 and above). The lower numbers would apply to you if your score is 680 or below. Keep in mind that a perfect score is 850. To get the best possible rates on loans you’ll need a score of at least 730 to 760, depending on the lender.

Translating point losses into dollar losses

As I noted above, there’s more than one reason to maintain a good credit score. But most obvious is that bad scores mean less access to credit and higher interest rates when you are given credit. Reduced access to credit means lost opportunities for you. Higher interest rates can cost you a ton of money.

Consider the mother of all debt: a home mortgage. Let’s say you’re borrowing 200 grand on a 30-year fixed mortgage. Show up at the lender’s office with a 620-639 credit score, and you’ll pay 4.88 percent. If you make minimum payments, your total interest bill for that mortgage will amount to $181,248 over 30 years. But if you waltz in with a 760 score, you’ll only pay 3.291 percent and your total interest bill over the life of the loan declines to $114,971.

That means that over the life of that loan, that lousy score cost you $66,277: Enough to finance your own business, put a kid through a good college, or retire at least a year earlier.

By the way, the information above came from Fair Isaac’s calculator. Check it out for yourself.

The opportunity cost of bad credit

Another even more dramatic way of looking at the same thing is to consider opportunity cost: What money you spend today costs you in terms of the opportunity to have more money tomorrow.

Here’s what I mean: because of the higher rate, a low score on our $200,000 loan means a monthly payment of about $875 a month versus about $1,059 for the higher score. In short, the person with the higher score has the opportunity to save an extra $184 a month. If they use that opportunity wisely and invest their $184 monthly for 30 years and manage to earn 6 percent on it, they’ll end up with $175,617. Even at 4 percent interest, that monthly savings of $184 would become $124,432 in 30 years.

Bottom line? Bad credit is a very expensive burden. If more people realized that, maybe we’d have fewer lousy credit scores floating around out there. According to Fair Isaac’s numbers, about 40 percent of Americans have a credit score below 700.

Of course, if you lose your job, can’t find another one, can’t pay your mortgage and can’t sell your house, there’s not much you can do to prevent getting behind. The same is true if you have a long illness and are saddled with huge medical expenses. But if you screw up your credit by carelessness or from living beyond your means, you’re giving up more than a low rate on a mortgage: You’re mortgaging your future and risking your retirement.

How has your credit score affected your life? Share with us in comments below or on our Facebook page.

Stacy Johnson

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