Whether you’re planning to borrow money in the near future or not, you need to be paying attention to your credit.
A consumer’s credit history and credit score represent their borrowing habits and history. And because no one can predict the future, lenders instead rely on credit reports and scores. These can tell lenders how likely a borrower is to responsibly repay a debt — or represent a risk that the lender would lose money.
Here’s a general overview of credit score ranges:
- Poor credit – 300 to 579
- Fair credit – 580 to 669
- Good credit – 670 to 739
- Very good credit – 740 to 799
- Excellent credit – 800 and up
If you ignore your credit or it’s already poor, this bad credit can come with big costs. Here are four common costs you might face if you have damaged credit.
1. Higher interest rates
The most direct cost of bad credit is likely the higher interest you’ll pay on any funds you borrow, from a credit card to a mortgage.
Why does bad credit almost always translate to higher interest costs? As mentioned, credit is used by lenders to determine their own risks. They view applicants with lower credit scores as more likely to miss payments or default on the debt — costing them money. Charging higher interest rates offsets this risk for lenders.
But for you, higher interest rates are a big financial burden:
- Increased monthly payments restrict cash flow. On a $200,000 mortgage, for example, a one-point rate difference of 4.25% to 5.25% increases monthly payments by $120 per month, according to Credit Karma’s amortization calculator.
- A higher portion of monthly payments goes to interest. As a result, your principal decreases less each month. This means it takes longer to repay the principal, and you’ll pay higher interest on a higher amount each month.
- Total interest costs are much higher. With our mortgage example, the rate of 5.25% results in $43,400 more in interest payments over the life of a 30-year loan compared to a 4.25% rate.
- Debt takes more time and money to pay off. With higher interest and lower cash flow, the path to pay off high-interest debt is longer and more expensive.
2. Extra loan fees
On top of charging higher interest rates, some lenders also charge origination or loan fees. Origination fees or other loan fees are one-time costs you pay when your loan is created, often a percentage of the total loan amount.
With some types of products, such as personal loans, lenders will determine a specific applicant’s fee based on their loan term and, yep, their credit score.
A typical personal loan origination fee is between 1-8%. With poor credit, a lender is more likely to charge you an origination fee on the higher end, pushing up your total borrowing costs.
3. Higher insurance premiums
Insurance companies, like lenders, are always looking for ways to limit their risks. Studies indicate that poor credit might correlate to costlier and more frequent claims against insurance. So insurers — in states where the practice is allowed — might rely on consumer’s credit histories to help them offset risks and set rates for personal insurance, such as homeowners and auto insurance.
Instead of using credit scores as lenders do, insurance companies use “credit-based insurance scores.” These parse information on your credit report such as your current debt, borrowing habits, and repayment record to generate your insurance score. Bad credit will give you a less favorable insurance score — and increase the rates insurers are willing to offer you.
Bottom line: while your credit score and insurance score are different, they’re based on similar credit factors. Think: making on-time payments, paying down credit card debt, and building a longer credit history. So changes that will improve your credit score are also likely to help you qualify for lower insurance premiums down the line. Check your state’s insurance laws. Some states don’t allow insurers to consider credit when setting certain insurance premiums.
4. Additional rental deposits
When it comes time to move, poor credit can add to your costs through higher security deposits. Although deposits are refundable, this upfront cost can impact your finances. You’ll probably miss having those funds on hand.
Many rental applications include a credit check, and landlords view poor credit as a sign of financial mismanagement. Many will deny applicants bad credit history outright. After all, if a tenant fails to pay rent, they lose money. If they decide to approve someone with poor credit, they could require you to put down a large security deposit on the property.
Whether you rent or own, you need to set up the utilities in your new home under your name. Utility companies might check your credit. If they see a spotty payment history or low credit score, they could require a security deposit. In Fairburn, Ga. for example, residents with a credit score below 700 will have to pay a deposit of up to $350 on water or electric services.
Building good credit opens doors
Finally, it’s worth mentioning the opportunity costs of bad credit — the missed opportunities that result from a poor credit history.
Maybe you can’t take advantage of a 0% credit card offer that could help you pay off debt. Or a bad credit score keeps you from qualifying for that apartment with a shorter commute to work. In some cases, a spotty borrowing record could even cost you a career opportunity if a potential employer includes a look at your credit report in its job application process.
Raising your credit score makes your life simpler, gives you more options — and can save you a lot of money.
Figuring out credit scores can be confusing, and it can feel like past credit mistakes will always follow you around. But they won’t. While improving your credit literacy and rebuilding your credit might not happen overnight, the progress and rewards are very real.