Credit scores are super-important to your overall financial health for at least three reasons. First because a bad score means higher rates when you borrow. Second because a low score can also 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 because a low score could also impact 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? Debatable. But like it or not, it’s a fact. So it quite literally pays to keep track of your score and keep in the best possible shape.
The company that produces the most-used credit score is Fair Isaac. While they have been forthcoming with the components of credit scores (here’s a link to Fair Isaac’s website where they explain that) they never provided the specifics of common mistakes on scores. Not, that is, until recently.
As you saw in the news story above, Fair Isaac finally coughed up just how much some mistakes will hurt your credit score. The first report I saw of this development was this story from MSN’s Liz Pulliam Weston.
To recap those I mentioned in the story and add one more (maxed out card):
30-day 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 would generally apply to those with the highest scores (780) and the lower end to those with lower scores (680). Keep in mind that a perfect score is 850, and to get the best possible deals, depending on the lender, you’ll need 730-760.
Translating point losses into dollar losses
As I noted above, there’s more than one reason to maintain a good credit score. But the most obvious is that bad scores mean less access to credit and higher interest rates if you get credit. Less access to credit means lost opportunity. Higher rates can cost you a ton of money.
Consider the mother of all debt: a mortgage. Let’s say you’re borrowing 200 grand on a 30-year fixed mortgage at today’s average rates. Show up at the lender’s office with a 620-639 credit score and you’ll pay 6.277%. If you make minimum payments, your total interest bill for that mortgage will amount to $244,582 over 30 years. But if you waltz in with a 760 score, you’ll only pay 4.688% and your total interest bill over the life of the loan declines to $172,900.
That means that over the life of that loan, that lousy score cost you $71,682: enough to finance your own business, put a kid through a great 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 $1,200/mo vs about $1,000/mo for the higher score. In short, the person with the higher score has the opportunity to save an extra $200 month. If they use that opportunity wisely and invest their $200 monthly for 30 years and earn 8% on it (possible in the stock market historically, albeit not in recent years) they’ll end up with $298,000.
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% 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. Likewise if you have a long illness and happen to be one for 45 million Americans without health insurance (seriously: what is this country thinking about?) But if you screw up your credit by carelessness or living beyond your means, you’re giving up more than a low rate on a mortgage: you’re mortgaging your future and losing a possible opportunity to retire rich.