It’s not just a number. Failing to take steps to improve your credit score could cost you hundreds or thousands of extra dollars on a home loan, a car payment or a credit card or insurance bill.
Sure, you know your credit score can affect everything from whether you qualify for a mortgage to whether an employer hires you, but have you ever made a plan to consciously improve your score? If not, it can be costing you dearly.
“When it comes to mortgages, auto lending and credit cards, the higher your score, the lower the interest rate you’re going to pay,” says Barry Paperno, manager of customer service for credit-scoring company Fair Isaac, which created the widely used FICO credit score. So the time and effort it takes to improve your credit score could save you hundreds of thousands of dollars over the course of your lifetime.
Loans and scores
For most people, a mortgage loan is where they’ll reap the greatest rewards from an improved credit score.
“For the past two or three years, mortgages have been the lowest in 30 or 40 years, but that doesn’t apply to everybody,” says Janette E. Jones, mortgage consultant for American Home Mortgage in Bethesda, Md. “That applies to people who have excellent credit. Someone who has excellent credit can actually get a fixed-rate loan for 5.5%. However, for people who have less-than-excellent credit — and I would say that’s anything below 650 (on the FICO scale of 300 to 850) — they’re looking at an interest rate that’s 1% higher, at the bare minimum.”
While the median FICO score in the United States is 723, which would yield favorable loan conditions, for those whose score falls way below that mark, the ramifications are costly.
A median of 723 means half the people fall below that score and half have scores higher. More specifically, here’s a breakdown of how scores are distributed across the population, according to MyFICO:
| Score | % of population | Score | % of population | |
|---|---|---|---|---|
|
300-499 |
2% |
650-699 |
15% |
|
|
500-549 |
5% |
700-749 |
18% |
|
|
550-599 |
8% |
750-799 |
27% |
|
|
600-649 |
12% |
over 800 |
13% |
|
According to MyFICO, a division of Fair Isaac, a consumer with a FICO score between 720 and 850 might get a 5.922% rate on a $200,000 30-year fixed mortgage rate. That would give him a payment of $1,189 a month and $228,072 in interest over the life of the loan. A consumer with a FICO score between 675 and 699 might get a 6.584% on the same loan, which would cost him $1,275 a month, with $259,074 in interest over the life of the loan, or $31,002 more.
The consumer with a FICO score between 620 and 674 might get a 7.734% rate and pay $1,431 per month, costing him $315,021 in interest over the life of the loan. That’s $55,947 more than the middle-score borrower and $86,949 more than the borrower with excellent credit.
Worse yet, a consumer with a score between 560 and 619 might get an 8.531% rate, pay $1,542 per month and pay $355,200 in interest over the life of the loan. The difference in interest paid over the life of the loan between the first and last example is more than $127,000.
If at first you don’t succeed
While the dollar amounts are most striking when it comes to primary mortgages, the effects of lower credit scores are not limited to your purchase of a home. If you want to refinance and pull out some cash to finish your basement or pay off some credit-card bills, your credit score can not only determine your interest rate, but it can also dictate how much of your equity you can cash out. The higher your credit score, the higher the amount you’ll be able to pull out. “Someone with a credit score of 580 might only be able to receive 70% of the equity in their home while someone with a 600 might be able to take out more,” says Jones.
Likewise, if you want to take out a home-equity loan of $20,000, your credit score could cost you thousands of dollars. According to MyFICO, a consumer with a score between 720 and 850 might qualify for a rate of 7.911% and pay $190 a month and $14,219 over the course of the loan. For that same $20,000, a consumer with a credit score between 640 and 659 might qualify for a rate of 9.486% and pay $209 per month and $17,562 over the course of the loan.
Auto loans can be just as costly for people with lower credit scores. For a $20,000, 48-month auto loan, MyFICO calculates that a consumer with a score between 720 and 850 might qualify for a 6.282% rate and pay $472 per month. That same consumer would pay $2,670 in interest over the four years of the loan. A consumer with a FICO score between 660 and 689 might qualify for an 8.844% rate and pay $496 per month and $3,819 in interest over the course of the loan. That same car cost the second borrower an extra $1,149 — $23.94 a month — just because of a lower credit score.
The insurance factor
A low credit score can also cost you more when it comes to your auto and home insurance.
Someone with a credit score of approximately 650 or higher could receive a discount of anywhere from “a few percent to 15% or even more” says Robert Hartwig, chief economist for the Insurance Information Institute.
Insurers use credit scores as one of the factors in determining what’s known as an insurance score.
“We’re not looking to see whether you’re worthy for credit; we’re trying to find the elements in the credit profile that correlate with loss behavior for insurance,” says Hartwig.
Numerous studies have found that people with lower credit ratings file more claims. There are some theories as to why this is so. “Individuals who have credit problems may well be more likely to defer important maintenance on their cars and their homes,” Hartwig suggests. “So those bald tires don’t get replaced, the brakes don’t get fixed, the leaky roof doesn’t get repaired and so on and so forth.”
The impact of credit scores on insurance scores varies from insurer to insurer and state to state. Some insurers only use insurance scores for screening new customers, while others routinely check the credit of existing policyholders when it’s time to renew their policies. But consumers can improve their chances of qualifying for a lower premium rate by keeping their credit score in the mid-600s or above, Hartwig says.
No one wants to throw away money. But by failing to take steps to improve your credit score, you could be giving up thousands of dollars a year. The best way to improve a blemished credit rating is to pay your bills on time and keep debt to a minimum, says Paperno.
“Everyone should work hard to maintain a strong credit rating,” says Hartwig. “If you work hard, you build a good credit rating and if you maintain it over time it has many, many benefits.”
By Tamara E. Holmes, Bankrate.com
{ 1 comment }
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