I’ve often been asked what is considered a bad credit score and exactly how much a bad credit score will cost you over your lifetime. And while that question is hard to answer definitively for every person reading this, it is a fact that poor credit score will make your life more expensive across a variety of services. Higher interest rates, larger deposits, more expensive premiums, and the lack of access to quality financial services are all ways a poor credit score can cost you more. But, exactly how much more?
No two people have the same credit appetite so you can’t simply say that poor credit will cost you $500,000 over your consumer credit life cycle. Someone who leans heavily on credit is clearly going to have a larger penalty than someone who chooses to pay cash for everything. However, if you were to compare apples to apples across similar loan products, it doesn’t take long to see just how expensive bad credit can become.
If you have poor FICO or VantageScore credit scores, you’re not going to get as low of an interest rate on a mortgage loan as someone with great credit scores would. That’s simply a fact, and it can be an expensive one. Keep in mind, too, if your scores are too low, you could be denied outright.
According to Informa Research the average interest rate on a 30 year fixed rate mortgage for a consumer with a FICO score of 760 or above is 3.8 percent. If you were to take out a $200,000 mortgage loan at 3.8 percent your monthly payment would be around $935. If, however, you had a FICO score of 650, the same mortgage loan would cost you 4.9 percent, which is still a pretty good interest rate historically speaking.
At 4.9 percent, however, your monthly payment on that same $200,000 mortgage would cost you about $1,060 each month. That’s a difference of $125 each month. This doesn’t sound like that big of a deal until you start annualizing the figures. Each year you’ll pay $1,500 more in interest and if you live in the house for five years that means $7,500 more in interest.
If you live in an area where the cost of living is considerably more expensive—Bay Area, New York, Chicago, Atlanta, Los Angeles—then the numbers are much more impressive. Using the same score difference in the previous example, and a $500,000 mortgage you’ll pay $3,670 more per year and over $18,000 more over five years.
These figures assume one house and one loan, but that’s not necessarily reality. Most homeowners buy several houses over their lifetimes. I’m 45 and I’ve already purchased six (and sold five). Point being is that your added cost of home-ownership is compounded because you’ll be paying more on several, consecutive or concurrent, mortgages over your lifetime.
The average rate on a general use credit card is somewhere around 15 percent, depending on the various sources. That is likely to be the most expensive debt you’ll ever service, and 15 percent is just the average. The cost of a poor credit score relative to credit card debt is much more pronounced than any other financial service.
At 15 percent, someone carrying even a modest $5,000 in credit card debt and making the minimum payment will end up paying back over $12,000 and it will take over 27 years to do so. That’s the best case scenario.
Someone who has poor credit is going to pay a considerably higher interest rate on their credit cards. It’s not unheard of for someone to pay almost 30 percent interest on a subprime credit card. So, doing the same math on the same amount of debt in the previous example, the new numbers look like this…(you may want to sit down):
At 30 percent someone carrying $5,000 in credit card debt and making the minimum payment will end up paying back over $132,000 (that’s not a typo) and will take over 30 years to do so.
It doesn’t end with mortgages and credit cards, although their divergence is clearly the most expensive and impressive. Auto loans, insurance premiums, and utility companies all use credit scoring as a basis for your rates, premiums and deposit requirements. There’s simply no getting around it. Poor credit scores make life more expensive.
Lastly, having a bad credit score makes it difficult to even obtain a credit card. Credit cards for bad credit scores are often secured credit cards.
5 credit horrors and how to handle them
Now let’s take a look at five credit horrors, along with tips from personal finance expert Liz Weston on avoiding them—or at the very least, getting your finances back on track.
Carrying a high balance
In addition to costing you money in interest, credit card balances raise your debt utilization ratio (the amount of money you owe compared to your available balance), which can lower your credit score and increase your risk of bankruptcy.
“People think erroneously that that credit card debt is somehow normal,” says Weston, author of There Are No Dumb Questions About Money. “I encourage people to make sure you don’t charge more than you can pay off each month even if it means bating beans and rice for the rest of the month.” If you’re already in debt, she suggests cutting back on spending and bringing in extra money so you can pay it off.
Cosigning on a loan
Say you have a friend or relative with credit issues who’s having trouble getting approved for a lease on apartment or a loan on a car. If you cosign for that person and he or she defaults, then your credit could suffer, too. “You’re essentially handing your credit history and your credit future over to someone who is not creditworthy,” says Weston. “If they were creditworthy they could get credit on their own.”
Her advice? Don’t get “tricked” into cosigning for anybody. And if you’re already in that position? According to Weston, “if the person is making payments on time and they have built up a little credit history, you can ask if they can find a way to refinance the loan in their own name. That’s the best-case scenario. The alternative is to say ‘I’m taking over the payments, you’ll pay me from now on.’” You’ll have to absorb that cost if they pay you late (or not at all), but at least it won’t trash your credit.
Missing a payment
If you have a good credit score, then one or two missed payments may not seem like a big deal. But making a payment 30 or more days late can reduce your score by up to 110 points, according to Weston.
“Something you’ve taken years to build up can be really hurt overnight,” she adds. Instead of waiting for a paper bill to arrive and prompt you to make a payment, she suggests automating payments online. That way, if you’re traveling or a bill gets lost in the mail, your credit won’t suffer.
Having your identity stolen
It’s no treat when someone else applies for credit cards or loans in your name, because those accounts can show up on your credit report card and lower your score. Unfortunately, Weston says it’s impossible to completely eliminate the risk, but checking your credit report annually can alert you to a problem. If you do notice an issue, then consider putting a fraud alert on your credit file or getting a credit freeze. A fraud alert is a free, short-term option that “signals to lenders that they should take extra steps to make sure that whoever’s applying for credit is who they say they are,” explains Weston. A credit freeze may cost you money, but it ensures that only your current lenders have access to your credit file so no one can open new accounts in your name while your credit is frozen.
Getting fraudulent charges
Even if your identity isn’t outright stolen, you could fall victim to small, unauthorized charges like extra ringtones or horoscopes on your phone that you didn’t even know about. That’s why Weston recommends reviewing each credit card statement carefully and disputing suspicious charges.
“Don’t let even small charges go under the radar,” she says. “A lot of businesses out there make a lot of money charging small amounts for things you didn’t order. The nice thing about a credit card is you’ve got a middleman to help you with these disputes.”
But why do people act the way that they do when it comes to their poor credit?
Are you constantly using your credit cards even though you know they are nearly up to their credit limits? Do you worry that you might not be able to pay even the minimum amount due when the bill comes but keep charging anyway?
“Most people are completely unaware of underlying money beliefs formed during childhood that may be causing poor money habits,” explains Brad Klontz, financial psychologist and author of “Mind Over Money,” who studied this phenomenon and published his findings in the Journal of Financial Therapy in 2011.
He says we all have unconscious “money scripts” playing in our heads from childhood moments when you see something happen you relate to money, often with intense emotion attached to it, that can lead to your specific good and bad financial behaviors.
You might be a money worshipper
“When your cards are maxed out and you keep charging and rationalizing the financially harmful behavior to yourself, you are most likely a money worshipper,” explains Klontz, “because you believe having more money will indeed solve all your problems and having more things will make you feel better.”
If you think about your earliest money memories, or even your most joyful or most painful money memories, you may find they have to do with someone who is happier because they have more money than you or your family.
His study found that money worshipping is associated with compulsive hoarding, excessive risk-taking, gambling, workaholism, overspending and compulsive shopping disorders. Money worshippers tend to have lower income levels and are more likely to carry debt.
So, your cards are probably maxed out
When your credit cards are “maxed out” that’s called “high credit utilization” in the credit industry, and you probably have a lower-than-average credit score because of it.
In analyzing Credit Sesame users’ six million credit scores, we found most of those with the lowest credit scores (even up to the 500s) also have the highest credit utilization, above 90%, which means they have used up most of their available credit. In fact, approximately one-third of these credit users with low credit scores in the 500s are actually over-the-credit-limit and overusing their credit cards.
The average Credit Sesame user has a credit score between 620 and 660, and the Experian State of Credit report found the average credit score was 666 in 2014. Even these less-than-excellent scores had high credit utilization levels between 70% and 45% respectively. The very best Credit Sesame user scores between 760 and 840 all had credit utilization below 15%, which is what credit experts advise for good credit.
The reason maxed out credit cards results in a low credit score is because the amount of your credit you’ve used represents 30% of your FICO credit score and a similarly large portion of your VantageScore, too.
But maybe you have already heard that.
So why are you still charging?
You probably have well-used excuses and easily say any of these things to yourself, while swiping your maxed out credit card, yet again.
But, Klontz says there is an element of truth in each thought and to turn around your harmful financial habits, you need to turn around the thought first. Here’s how.
1. “This is an emergency and I need this now (that’s why I have this credit card).”
“What you really need is financial security, which you will never find in a credit card,” says Klontz.
A safer, more financially protective way to meet this need is by building a cash emergency fund (however slowly) to use instead of a credit card for new tires, brakes, an exploded water heater or medical co-payment.
2. “I deserve these pair of shoes or night out (even though I can’t pay my bills each month).”
“You really do deserve to take care of yourself but there are many more meaningful and functional ways that don’t cost money and keep you out of the malls,” advises Klontz.
Create a monthly budget that allows for a small but fun splurge, start that emergency fund, spend time exercising or meditating or with family members or outdoors or reading a new book. These are all things that are guaranteed and scientifically proven to make your mind and body feel better that you deserve, says Klontz.
3. “My problems have nothing to do with my finances (so I might be out of control in other areas of my life, too).”
Klontz explains it’s been proven that a lack of self-control in one area such as overeating can translate to a lack of self-control in other areas such as overspending.
“The good news is if you take control of one area of your life, that self-control can transfer to the other areas of your life,” urges Klontz.
Getting control of your finances and saying no to unnecessary purchases just might be the answer to how to improve bad credit scores. It can even be the spark that improves your life, more than financially.
4. “I’ll pay it with my next paycheck, even if it’s late (but never have enough money then, either).”
Klontz says our brains are wired for immediate gratification and even future late fees, high interest rates and poor credit scores are often not enough to stop us.
“You have to kick in to a higher level of thinking to conquer this habit, especially when overusing credit cards and payday loans,” says Klontz.
His advice? Instead of having your paycheck in mind when the urge hits to spend or swipe instead of making important payments due, use strong emotions. Imagine a highly emotional negative result of the spending (power being turned off, not having a car to drive, being 70 years old and still working at Walmart) or a highly emotional positive result of not spending (having money for a vacation, getting a great loan rate and driving off in a new car, having that emergency fund safety net).
Klontz says you can become more aware of your underlying thoughts and feelings about money by examining your earliest money memories and looking for patterns. When you realize these, you may be able to better make some concrete changes to your own money scripts and change your financial behavior and your credit score for the better.