What Is the Cost of Having Bad Credit?
The cost of having bad credit goes far beyond higher interest rates or lower odds of loan approvals. Bad credit can hinder your ability to get a job or even find a place to live if the landlord requires a credit check.
If your credit isn’t optimal, don’t despair. There are steps you can take immediately to start nudging it in the right direction. We’ll get more into that later, but first you need to have the full picture of what bad credit really means.
What is a bad credit score?
One of the primary ways your credit health is evaluated is through your credit score. Most top lenders (90%) use a score generated by FICO, making it the most widely used score at the moment.
Scores range from 850 at the top for those with virtually flawless credit to down in the 300s. Scores of 670 and above are considered “good” or better, while scores below 580 are “poor.” Scores that fall between 580 and 669 are considered “fair.”
How bad credit can hold you back
If your credit score is poor, you’re likely going to have trouble getting approved for all kinds of loans, from personal loans to mortgages. But a poor credit history can also affect your likelihood of getting approved for an apartment rental or even getting a job if the employer considers financial health a part of the job requirements.
If you do get approved for a loan, you’ll probably have to pay higher interest rates than those with better credit, which can add up significantly over the life of the loan.
Getting an auto loan with bad credit
When it comes to auto loans, those with very poor credit scores may pay interest rates four times higher than those with stellar credit, according to a 2019 auto debt study by LendingTree.
In the study, we found someone with excellent credit (720 or higher) secures an average 4.5% auto loan rate, while someone with a score below 560 gets an average rate of 18.05%. Ouch.
If those two people borrowed the same $25,000, 60-month term auto loan, they would pay significantly different costs over time. The person with excellent credit would pay about $3,000 while the person with poor credit would pay over $13,000 in interest over the life of the loan.
When you have poor credit, shopping and comparing loan offers before you head to the auto dealership is the most crucial step you can take to be sure you’re getting the best deal possible. Check out our tips on shopping for an auto loan when you have poor credit.
Getting a mortgage with bad credit
A home is the single most expensive purchase most Americans will ever make. Even a difference of a single percentage point can have a huge effect on the cost of your mortgage over a 30-year loan.
As of this writing, someone with a credit score of 760-850 looking to take out a $350,000 mortgage would pay a staggering $119,544 less in interest charges over the life of their mortgage compared to someone with a score of 620-639, according to MyFICO’s loan savings calculator.
Not only can bad credit add tens of thousands of dollars to the cost of your mortgage interest, it can also result in a much higher monthly mortgage payment. In the same example, the person with the higher credit score would have an estimated monthly mortgage payment of $1,630, compared to $1,963 for the person with the lower score.
Getting a personal loan with bad credit
Shopping for a personal loan with poor credit is like walking through a bit of a minefield. There are certainly lenders willing to work with borrowers who don’t have the best credit histories, but they may do so at a steep price. In our most recent analysis of personal loan rates by credit score, we found a huge difference in rates for borrowers with the best versus worst credit scores.
People with the highest credit scores enjoy average personal loan APRs of 7.09%, while borrowers with the lowest scores are stuck with rates nearly 20 times higher — a staggering 135.94% on average.
When you’re shopping for a personal loan with poor credit, this is one of the reasons we recommend starting with a local credit union and comparing loan options from several lenders. Federal credit unions are required to cap their rates on loans at 18% APR, so if you can manage to secure financing there you’re much better off than you might be at private banks or online lenders.
Check out more tips on getting a personal loan with bad credit here.
Know your score before you shop for loans
To calculate your FICO Score, five separate areas are considered, each of which has a varying degree of weight.
The most significant factor (accounting for about 35% of your score) is your payment history, meaning how well you pay your bills on time.
The other factors considered are the amount of debt you owe and how much of your available credit you’re using (30%), the length of your credit history (15%), new credit (10%) and your mix of different types of credit (10%), such as mortgage loans, credit cards and retail accounts. FICO considers all of this to calculate your FICO Score, a number that fluctuates regularly.
And yes, you want to know your score. Even if you fear the news isn’t going to be good, it’s better to know what you’re up against. Check your score for free through My LendingTree.
Beyond your credit score
As important as your credit score is, it’s not the only determining factor when it comes to your ability to secure a loan. While your credit score doesn’t take into account things like your income or employment status, lenders typically will. They may look at your debt-to-income ratio, which compares your monthly debt payments to your gross monthly income. If your DTI ratio is too high, you may not be approved for a new loan.
Leslie Tayne, a financial debt resolution attorney in New York, said people think they have good credit based on their credit score alone, but that can be “like a false positive” if they have just $20 in the bank and little to no income.
“It’s not just a number,” Tayne said. “Credit has to do with your ability to be a good borrower. You could have a great credit score but still not be a candidate for a loan. Your credit is based on your overall financial health.”
The risk of borrowing with bad credit
So, what if you need a loan and your credit is too poor to qualify for traditional loans? The good news is there are options, but the bad news is most of them are bad for your financial health.
Many services are advertised as quick and easy ways to get cash fast, no matter your credit or income. What they’re not telling you is just how much they can end up costing.
In many cases, they can and will take you deeper into debt and drag your credit score down even further. Those include payday loans (often advertised as “signature loans”), loans from self-financing auto dealers, title loans and credit card cash advances.
Most of these come with astronomical interest rates and sky-high fees that are difficult to pay back. Be wary of any of them, and if you must turn to one as a last resort, know exactly what you’re getting into and have a plan to get out of it as quickly as possible.
The best way to avoid these types of loans and to avoid getting trapped in a debt cycle is to improve your credit score and your overall financial health. Over time, you’ll qualify for loans with better interest rates and terms.
The best way to save on loans: Improve your credit score
No matter how bad your credit is now, there are things you can do to start moving it in the right direction, and it doesn’t take as much time or effort to see movement as you might think. Here are some ways to start improving your credit score right away:
Pay on time
The single most important thing you can do to improve your credit score is to pay your bills on time. Also, try to pay more than the minimum balance when possible to keep your balance as low as possible (optimally less than 30% of your available credit limit), and pay off the balance in full when you can.
Check for errors
Even if you’ve made some financial mistakes, the last thing you want is additional mistakes that aren’t your fault on your credit report. As many as 20% of consumers have mistakes on one of their credit reports, so it’s worth checking yours. If you do find any, you’ll want to take steps to dispute the errors.
If your own efforts aren’t producing the right results, you may want to turn to a credit repair service. These companies can help you negotiate with creditors to work out payment plans and help get negative marks removed from your credit history. Just beware of scams and make sure you look for a reputable service.
Wait it out
Time is your friend when it comes to your credit. Late and missed payments stay on your credit report for up to seven years before falling off your report. Bankruptcies can stay there a little longer (10 years) depending on the type of bankruptcy. If you do nothing but wait it out and make your payments on time, your credit score will improve over time.
Even if your credit score is already in decent shape, raising it even higher can pay off significantly. In fact, according to a LendingTree study, someone who raises their credit score from “fair” to “very good” could save more than $45,000 when it comes to common debts (including credit cards, loans and mortgages) as a result of the better interest rates offered.
As we’ve shown above, the cost of bad credit can be astronomical when you are borrowing funds. If you’re shopping for loans with bad credit, be sure you use tools that can help you compare and contrast multiple offers from several lenders. This is the best way to ensure you’re getting the best deal.