In today’s financial landscape, maintaining good credit is more than just a status symbol, it’s a necessity. With crucial life events like home ownership, car purchases, and even job opportunities hinging on it, a poor credit score can cost you significantly. From higher interest rates to denied loans, the impact of bad credit can be far-reaching and more expensive than most people realize. This article aims to shed light on the true cost of having bad credit and provides actionable steps to improve your financial standing.
Understanding Credit Scores
A credit score is a three-digit numeral, ranging from 300 to 850, that represents your creditworthiness. It’s a key metric lenders use to assess the risk they take when lending you money. The lower your score, the riskier you appear to lenders, which can affect your ability to secure loans or leases.
Categories of Credit Scores
Credit scores generally fall into five categories:
- Bad Credit: 600 and Below
- Poor: 600-649
- Fair: 650-699
- Good: 700-749
- Excellent: 750 and Above
The higher your score, the more opportunities you have for lower interest rates and better loan terms.
How Credit Scores Are Calculated
They are calculated based on your credit report information, typically gathered from the three major credit bureaus in the United States: TransUnion, Equifax, and Experian. The most widely used method to calculate credit scores is the FICO method, which considers five key factors:
- Payment History (35%): This factor considers whether you have a history of paying your debts on time.
- Total Debt (30%): This is not just about the amount you owe but your “Credit Utilization Ratio” which is the percentage of your available credit that you’re currently using.
- Length of Credit History (15%): Typically, a longer credit history is better. However, those just starting can still maintain a high credit score by carefully managing other factors.
- Type of Credit (10%): This involves the variety and number of credit accounts you have. While maintaining credit accounts is good, opening an account you don’t intend to use can negatively affect your score.
- New Credit (10%): Frequently opening multiple new lines of credit can negatively impact your credit score.
Checking Your Credit Score
You’re entitled to one free credit report per bureau every 12 months. However, to get your credit score, you’ll most likely have to pay a fee. Certain banks offer free credit scores with memberships. You can purchase your score directly from FICO or find a credit report monitoring service you like and purchase a subscription to get your credit score included for free.
Why Is My Credit Score Important?
Your credit score impacts milestone purchases. When the time comes to go back to school or buy that dream home, you don’t want your credit score standing in your way. A bad credit score is not only inconvenient, but it’s also costly. Even if you’re approved for a loan, your interest rate is largely determined by your credit score.
The High Price of Bad Credit
Let’s explore how poor credit can financially impact three significant areas of life: home ownership, car ownership, and credit card usage.
The Impact on Mortgages
The average home cost in the U.S. is well over $300,000. Securing a mortgage for such an amount is significantly influenced by your credit score. For instance, if you have a high credit score, you could secure a lower interest rate on your mortgage, saving you thousands of dollars over the life of the loan. However, with a low credit score, you may face higher interest rates or even be denied a mortgage altogether.
The Impact on Car Loans
The cost of new cars has increased significantly in recent years, leading to larger auto loans. Poor credit can lead to higher interest rates on these loans, resulting in more money paid out over the life of the loan. Moreover, it can also influence your car insurance rates, potentially leading to higher premiums.
The Impact on Personal Loans
Bad credit can also affect your personal loan interest rates. According to OutlookIndia, the average household with personal loan debt owes over $20,000. If you have poor credit, you could be paying significantly more in interest on this balance than someone with good credit. Moreover, late fees — which are more common among installment loan users with poor credit — can add to this cost.
The Long-Term Impact of Bad Credit
While it’s hard to pin down the exact cost of many of these purchases, these are good estimates. The interest rates are from January 2016 and the costs are 2015 national averages.
When we look at how quickly these costs build up, it’s easy to see why it’s worth spending time on your credit score now, rather than spending money on it later.
Improving Your Credit
This is a process that requires patience and discipline. Here are some actionable steps you can take:
- Sign up for free credit monitoring to keep track of your progress.
- Create a sustainable household budget that doesn’t rely on further borrowing.
- Prioritize paying down high-interest debt.
- Look for opportunities to refinance your debt at lower interest rates.
Remember, the journey to improving your credit score is a marathon, not a sprint. However, the financial savings you stand to gain in the long run make it well worth the effort.
Maintaining good credit is an essential aspect of financial health. With significant life decisions and opportunities often hinging on your credit score, the cost of poor credit can be far-reaching. However, it’s never too late to start improving your credit. By understanding the impact of poor credit and taking steps to improve your score, you can save thousands of dollars and open up new financial opportunities.
It’s time to take control of your financial future. Start today by checking your credit score and making a plan to improve if needed. Remember, every point increase in your credit score is a step towards financial freedom and prosperity. In case you are being harassed by a creditor or debt collector, read this.