Your credit score is used by lenders to determine how much credit to issue, what interest rates tocharge and other credit terms. Lenders charge higher interest rates for borrowers with low creditscores while borrowers with high credit scores typically receive lower interest rates. Credit cardissuers also set credit limits based on credit scores and monthly income.
Interest rates and credit limits are not the only terms set based on credit scores. Insuranceproviders are beginning to set premiums based on credit scores. Property managers set rentaldeposits based on credit scores. Service providers, such as residential and mobile phonecompanies, approve accounts and set deposits based on credit scores. FICO scores range from 300 to 850, with 850 being the best possible score.
The average creditscore is 675 and the median credit score is 725. Typically, any credit score over 720 is eligiblefor favorable credit terms, like a low interest rate, while credit scores below 660 usually can onlyqualify for expensive, high-interest “subprime” credit.The average American has about $10,000 in credit card debt and the average annual percentagerate (APR) is about 15% (1.25% monthly periodic rate). If this average American paid 2.5% of the debt each month ($250), it would take 26 years to pay off the debt and cost $9,757.71 ininterest. So, this average American borrows $10,000 and pays back nearly $20,000.Now, imagine two not-so-average Americans borrow the same amount on each cardholder’scredit card account. One, we will call him Jack, has a 780 FICO score and the other, Jill, has a600 FICO score. Jack was able to get a 9% APR while Jill’s credit card company gave her a 24%APR. Using the same low monthly payment model as the average American with the 15% APR,we can see how much bad credit can cost you.Jack, with a 9% APR (0.75% monthly periodic rate), will pay $250 each month for 19 years andfour months to pay off the $10,000 balance and only pay $4,191.60 in interest. Jill, with her 24%APR (2% monthly periodic rate), will have to pay $298 each month because of new regulationsrequiring credit card companies to set minimum payments no lower than all interest and fees plus1% of the account balance. This means that more of Jill’s monthly income ($48) is consumedwith minimum monthly credit card payments, but that’s not all. It will take Jill about 33 yearsand five months to pay off the entire balance and she will pay $19,949.30 in interest – nearlytwice what she borrowed!
As you can see, bad credit is costly. It cost Jill an extra $15,757.70. Bad credit can causeproperty managers to require hefty deposits (that’s assuming they approve your rentalapplication) and may even cost you an employment opportunity as some employers use creditreports to screen potential hires – and let’s not forget about insurance premiums. But these areonly the immediate costs of bad credit. Jill also lost over 14 years and $48 of monthly cash flowthat she could have used to pay other bills and buy groceries.
The cost of bad credit stretches beyond what you pay in interest, deposits and higher insurancepremiums. There are the lost opportunities because so much of your hard-earned money is beingsunk down the bad credit drain. Your credit card payments equate to $250 you are not investingeach month into a 401k, ROTH IRA or other investment account. If Jill was able to contribute$100 to her company’s 401k plan and her employer matched her $100 each month for 35 years,she could retire with about $760,000 (assuming a 10% annual rate of return).
So, low credit scores cost us far more than interest payments and even more than the lostopportunity to earn nearly one million dollars. Debt stress seeps over into our personal lives,causing marital stress, personal stress and even health problems. But don’t let these facts get youdown. Use them to motivate you in your efforts to better your situation and put the gloomy daysof poor credit behind you.
