By Jeffrey Strain Special to TheStreet.com 8/2/2007 11:04 AM EDT
You probably are well aware that a poor credit score costs you money, but you probably are not aware how much that can add up to over time -- sometimes well over $1 million.
For people with poor credit, the additional money they'll pay for things like mortgages, car loans and insurance, compared with what those with solid credit pay, can be in the mid-six figures over a 30-year period. Invest it wisely, and that number could soar to more than $1 million.
Here is how poor credit costs you in more ways than you imagined:
Mortgage: One obvious place that poor credit hurts you is the interest rate you must pay when you purchase a house. The average price for a home in June 2007 was $316,200.
According to MyFico, a 30-year, $300,000 loan for someone with a credit score of between 760 and 850 carried a 6.346% APR. Someone with a credit score of between 500 and 579 would have a 10.152% APR. That would mean that a person with a good score would have a monthly payment of $1,866, while the person with the poor credit score would pay $2,666 -- or $800 a month more for the same house. That adds up to $288,000 over the 30 years of the loan.
Auto loan: Edmunds.com says that the average car loan is $24,864. According to MyFico, an auto loan for a person with good credit (defined as a score of between 720 and 850) would carry a 7.221% APR, while someone with poor credit (a score between 500 and 589) would have to pay a 14.909% APR. That works out to a difference of $88 a month, which comes to $3,168 over the three years of the loan. The average person keeps their car for 4.5 years.
That means if each person financed a new car every five years, it would cost the person with bad credit $19,008 more in car financing over 30 years than someone with good credit.
Credit cards: Let's assume, for our exercise, that both the people with good and bad credit both carry the median credit card debt of $2,200 over 30 years. If the person with good credit had an interest rate of 9% and the person with bad credit had an interest rate of 20%, the person with poor credit will pay an extra $7,260 over a 30-year period.
Lost interest: If the person with good credit took the difference and invested that money in an account that earned 8% compounded annually for 30 years, he or she would have well over $1 million saved. In fact, investing the $800 difference in the cost of the mortgage alone would be worth $1.2 million.
Insurance: All types of insurance (auto, health, homeowners) will likely cost more for a person with poor credit than one with good credit. Insurance companies know that people with poor credit make more claims than those with good credit -- and therefore are more of a risk to insure.
If your credit score is taken into account on any of your insurance rates, an individual with poor credit will pay more than a comparable individual with good credit.
Job: You may lose out on a better job due to poor credit. More and more employers pull your credit report when you apply for a job, because many see a risk in employing a person with poor credit. The same can be true with promotions. For example, people in the armed forces may not be able to get clearance for classified documents and areas due to poor credit, therefore blocking potential advancement.
Housing: Many apartment managers will run a credit check on prospective tenants. If your credit is poor, you may be denied a unit due to the risk that you may not be able to pay.
Deposits: If you have poor credit, you may need to leave a deposit -- or a larger deposit -- with certain companies than you would if you had good credit. Utility and cellular phone companies sometimes ask for deposits with people that have less-than-stellar credit.
Health: In addition to all the financial aspects where poor credit will hurt you, it could also adversely affect your health. It's not difficult to imagine that a person who has to pay a couple of hundred thousand dollars more for the same house as a neighbor down the street could have some financial stress in their life. This stress can affect a person both mentally and physically, if the poor credit is constantly a source of fighting in the house.
Poor credit is no longer a situation that can be isolated from other areas of your life. The trend is only growing stronger. Take the time to make the effort to keep your credit in good standing. It will pay off with more money in your pocket and less stress in your life.
This is definitely a mixed bag for Fair-Isaac Corp.
On the one hand, they've got to be happy that their FICO scoring formula has been found to be so useful in so many ways. No doubt the number of FICO pulls has increased substantially in the past decade.
On the other hand, as credit scoring affects more and more people in more and more ways, those with bad credit are liable to start complaining to Congress, and regulatory pressures on Fair-Isaac can only increase over the next few years...
- - - - in a credit-scoring postnuclear Stone Age...
Everything needs to be sensationalized so a headline-grabbing number like $1 million can be used.
In reality, you'd think that someone who maintained a mortgage for 30 years, or was able to finance 6 new cars (one every 5 years), (1) would not have a credit score that remained firmly anchored in the basement for the entire 3 decades, and (2) would refinance the mortgage at some point.
Someone who could afford to "lose" an average of $33,333 every year - just on "additional" interest - would have options.
Oh, I agree the numbers are inflated. Were I that journalist's editor, I'd be having a few words with him, because I think the headline is misleading. But the "low-credit tax" is real, especially in states where insurers are permitted to take credit scores into account. And even if the actual amount is, say, $200K, that's still a hefty chunk of change.
- - - - in a credit-scoring postnuclear Stone Age...