The High Cost of Low Credit Scores

We all know bad credit doesn’t do anyone any favors, but renowned financial guru Liz Pulliam Weston recently put a dollar amount to the cost of an underachieving credit score. It’s eye opening, as you’ll see.

Weston compared two fictional women. Emily and Karen, two friends who borrowed about the same amount of money over their lifetimes. Here’s the breakdown of that borrowed money:

1. $20,000 in private student loans
2. $8,000 in average credit card balances
3. New vehicles every seven years through age 70 ($25,000 per vehicle)
4. First home at age 30; $300,000. Upgrade to $400,00 home at age 40
5. $50,000 home-improvement loan

The big difference between Emily and Karen? Emily has a FICO credit score of 750; Karen 650. Emily maintains her score primarily by paying her bills on time, but also not maxing out her credit cards. Karen is a bit lax about paying her bills on time, having had several late payments over the past few years. She’s also a lot closer to maxing out her cards.

The examples that follow are only for illustration purposes as real-life interest rates can go up and down over time.

Student loans (Private)
While federal student loans don’t take credit scores into account, private loans do. Karen could pay up to 6 percent more than Emily on her interest rates.

Emily
Interest rate:  7.25%
Monthly payment:  $234
Total interest (10 years):  $8,176

Karen
Interest rate:  13.25%
Monthly payment:  $302
Total interest (10 years):  $16,189

Karen pays an additional $8,013.


Credit cards
Emily
Interest rate:  10.99%
Annual interest paid:  $880
Lifetime interest paid:  $44,000

Karen
Interest rate:  19.99%
Annual interest paid:  $1,600
Lifetime interest paid:  $80,000

Karen pays an additional $36,000


Auto loans
Emily
Interest rate:  5.78%
Monthly payment:  $481
Interest cost per loan:  $3,843
Lifetime interest paid:  $30,768

Karen
Interest rate:  13.24%
Monthly payment:  $572
Interest cost per loan:  $9,310
Lifetime interest paid:  $74,480

Karen pays an additional $43,712.


Mortgage
House 1: 30-year, fixed-rate $300,000 loans paid over 10 years

Emily
Interest rate:  4.84%
Monthly payment:  $1,581
Total interest paid (10 years):  $132,592

Karen
Interest rate:  5.66%
Monthly payment:  $1,734
Total interest paid (10 years):  $156,802

House 2: 30-year, fixed-rate $400,000 loans over 30 years
Emily
Interest rate:  4.84%
Monthly payment:  $2,108
Total interest paid (10 years):  $359,004

Karen
Interest rate:  5.66%
Monthly payment:  $2,312
Total interest paid (10 years):  $432,221

For both homes, Karen pays an additional $97,427.


Home equity loan
15-year loan for $50,000
Emily
Interest rate:  7.82%
Monthly payment:  $473
Total interest paid:  $85,140

Karen
Interest rate:  10.89%
Monthly payment:  $565
Total interest paid:  $101,700

Karen pays an additional $16,560.

If you take all of Karen’s additional payments over a lifetime of borrowing, you’ll see she’s paying over $200,000 more in payments than Emily! And that estimate could be low, as Karen likely would pay more for auto and home insurance as well. And with higher payments each and every month, Karen has less money for everything else, from dining out to vacations. Keep in mind, her score was a 650. Imagine what her additional payments would be with a lower score, which is considered more risky?

As you can see, cultivating a good credit score pays off in a big way. It will not only save you big money over time, it can also open more doors. Did you know some renters and employers check credit scores?

What if Karen had invested that money instead?
If all that doesn’t strike a chord, consider this: if Karen had invested those payment differences each month over 50 years at an 8% average annual return, she’d have a retirement nest egg of over $2.3 million! That’s some nest!

Here's some info on how to keep your credit score as high as possible.

And remember, if you’re having budgeting problems, or just have concerns about your personal finances, Vantage offers members free financial education and counseling services through Accel.