Bad Credit vs Good Credit

The Cost of Bad Credit

It’s common knowledge that bad credit scores are detrimental to obtaining loans. But if a loan can be obtained with bad credit, it won’t be issued at the same interest rate as to those with good credit records. For some, this may not be a cause for consideration. But it probably would be if it was understood just how costly bad credit can be. The problem for those with bad credit is that each lender sets down their requirements for issuing credit. Each lender will also make loans at different interest rates based on the exact credit score of the applicant. Therefore doing your research prior to applying for a loan may be quite enlightening.

In any case, however, good interest rates and bad credit scores are just not compatible with one another. If a credit applicant, for example, has a FICA score that is below 500, they will usually be turned down for standard vehicle loans. There are special loans that can be obtained. But these will possess relatively high interest rates and will have higher monthly payments attached to the loan. When all is said and done, the high risk loan recipient may actually end up paying thousands of dollars more than what the vehicle originally cost. In addition, there are other areas that require loans that will be affected as well.

High financing rates

Whether you are financing a car, a house or anything else requiring a loan, that loan works the same as any bank loan. The loan recipient agrees to pay off the loan in a specific amount of time through a specified monthly payment. But those who possess a bad credit score will usually be required to make a higher down payment. The interest rate will be much higher and, in many cases, some form of collateral will be needed to secure the loan in the first place. This not only makes obtaining the loan difficult and time consuming, but turns the loan payback into an expensive proposition.

Higher down payments

As mentioned earlier, a higher down payment will usually be required for those with bad credit scores. When a comparison is made to those with good credit scores, you may be looking at a 50% down payment for bad credit vs. 10 – 20% for good credit. That means for an auto loan of $15,000, for example, a person with good credit will put down approximately $1,500 to $2,000. A person with bad credit will need to come up with about $7,500. When you combine a high down payment with double digit interest rates, you can see how much extra is paid by the person with bad credit.

Bad vs. Good Credit Comparisons

To further illustrate the cost of lower credit scores, let’s take a look at an example involving two fictitious borrowers. One has an excellent credit score of 720, while the other borrower has a fair to poor FICO score of 650. In this example, each person is taking out a $20,000 (after down payment) loan that is set to be paid over 5 years (60 months).

FICO score of 720 pays 4% Interest Rate. Monthly payments are $368.33 for 60 months.

FICO score of 650 pays 18% Interest Rate. Monthly payments are $507.87 for 60 months.

The difference is $8672.40 in total payments! That’s a good amount of money. But it can get much worse. Let’s say that each individual is purchasing a house for $150,000.

FICO score of 720 pays 5% Annual Interest Rate. Monthly payments are $805.23

FICO score of 650 pays 10% Annual interest Rate. Monthly payments are $1,316.36

The difference is $184,006.90 in total payments! I’m sure you can see the short term effects of bad credit in these examples, but what about the long term effects?

Bad Credit’s Long Term Effects

In the above examples, it’s pretty easy to see how bad credit can affect someone when it comes to dollars and cents. But there’s more to the story than just higher monthly payments. If a person has to pay more, each month, out of their pocket then there is little left for other things. This may translate into a family vacation that can no longer be afforded due to a car purchase. Other family outings may also be out of the question. You see, bad credit doesn’t just affect a bank account or a wallet – it can affect a family’s quality of life. In some cases it will directly affect the amount that can be saved for a family emergency. Retirement savings are also at risk. This is the true cost of bad credit.