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Quantifying The Real Cost of Bad Credit
What is the real cost of having bad credit? Let's take a quick look at automobile financing and mortgage loans to see if we can't put some specific numbers to it. Very quickly, you'll see that there is a very real, very quantitative cost to having a low credit score. On the other hand, you will also see how financially advantageous it is for you to work to increase your scores.
1. Automobile Financing.
If you are financing a car and have bad credit, you are probably paying thousands of dollars more than you would pay once you had restored your credit. This extra interest shows up every month in a dramatically higher payment. One of the first things a person often does once they have restored their credit is to refinance their automobile for a fraction of their current payment. Or, they sometimes buy twice the car at nearly the same payment they originally had.
The following numbers illustrate this additional cost. Imagine you purchase a car for $20,000 with car payments spread over five years. If you have an excellent credit rating, you can get a rate of 3.99%, giving you a monthly payment of $391.07. In this scenario, there is no added cost of having bad credit, because your credit rating is excellent.
Now, let's imagine purchasing the same car with a middle-of-the-road credit score. Your rate will jump drastically to the 12% range, providing you a monthly payment of $463.41. That's an added monthly cost of $72.34, or an extra $4,340.69 over the five year period. In other words, your lower credit score just cost you over four thousand dollars to purchase that car.
But, it gets even worse for those with poor credit ratings. Their interest rates will be around 18%, giving them monthly payments of $523.59. That's an extra $132.52 per month, or an extra $7,951.43 overall.
And, for those individuals with severely low credit scores, it may actually be impossible to buy a car at all in today's market. Think of the quality of life issues that would arise from such a scenario.
2. Home Mortgage.
The American dream of owning your home is out of reach for most people with credit problems. As you see below, even mildly damaged credit will cost a small fortune in additional interest. This forces credit challenged consumers to raise families in less desirable neighborhoods and to rent. They end up paying off someone else's mortgage.
This leaves them nothing to show for their years of payments, except several years' worth of rental receipts. Also, in today's home financing market, loans for borrowers with less than "A" credit are nearly impossible to find at any price.
Imagine a home purchase to be paid through a 30 year loan of $100,000. A decent credit score may get a rate at 6%, meaning a monthly payment of $601.06. But, a low credit score will mean a rate as high as 12%, if the mortgage will even be available. This means a monthly payment of $1,029.05 - that's an extra cost of $427.99 each month. In other words, that's an extra cost of $154,076.45 over the 30 year loan. The original loan amount is only $100,000; yet, the person with the lower credit score is paying an additional $150,000!
And, it gets even worse for mortgage seekers. In the spring of 2008, Fannie Mae and Freddie Mac (the two guarantors of conventional mortgages in the US) announced a new graduated pricing schedule based on your credit score. First, they will not offer mortgages for any score under 620. Second, they will also severely penalize you based on your score, even when you are approved for a loan. With these new price adjustments, you can pay up to an additional 2.75 points (2.75% of your loan amount) in fees just to get your loan if your scores are not high enough.
So, what does this all mean? Fannie Mae requires that your mortgage lender now follow their new guidelines when giving you a rate and price for your new mortgage. A price adjustment is not a rate adjustment. The percentages you see above are points that you would have to pay extra, in the form of extra fees. Or, instead of paying extra points or fees, the lender would be forced to raise your interest rate in order to cover this extra price requirement set by Fannie Mae and Freddie Mac.
Let's take a typical scenario and see how it could affect you. If you were putting 5% down on your new home that costs $200,000, and you had a credit score of 720 or higher, you would be offered a rate that includes no premium. But, if your credit score was only a 630, you could still get the same loan with the same down payment - but you would have to face two choices: either pay an additional 2.5% of the loan amount in order to get that same rate or take a much higher rate to avoid paying those 2.5 extra points.
On a $200,000 purchase with 5% down, your loan amount would be $190,000. That would mean that 2.5 extra points (2.5% of your loan) would cost you $4,750 extra cash at closing just to get the same rate as someone with better credit. As you can see, in today's lending world, your credit score makes a huge difference. In fact, it could even keep you from being able to afford the home or car you originally thought you could afford.
About the Author Chris Esposito, through CM Direct, specializes in home renovation loans for people who wish to buy and fix up a property through a home improvement project or a full, major rehab. To learn more about the home renovation loans, go to www.DirectRehabLoans.com, or call (877) 876-3688.
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