Credit Scores and Real Life

A few weeks ago, I was doing research for our podcast and radio show and found an interesting website article about how your interest rate on loans increases as your credit score decreases. It showed a chart that referenced credit scores to the interest rates for new and used car loans.

I knew that the interest rates were higher for people with bad credit but I never looked at the details about what that means as far as money out of your pocket. Let’s take a look at how that works on a loan for a new car.  

A buyer with an excellent credit score (781-850) would get an interest rate of 2.60% on a new car loan. A buyer with a poor credit score (501-600) would get an interest rate of 10.65% on that same car loan. If your credit score is in the bad range (300-500) you won’t even be able to get any loan.

Let’s break those interest rates down to dollars and cents. The average new car costs $33,500 and we’ll assume that your loan is for $30,000 because of a $1,000 down payment and your trade-in. If you have a 60-month loan (5 years) and you have an excellent credit score, at 2.60% interest, you will pay $475 per month and a total of $32,300. Over the five year life of the loan, you will spend $2,300 in interest payments.

However, if your credit score is in the poor range, and your interest rate is 10.65%, your monthly payments will be $590 and you will pay a total of $40,000 for the car.  A poor credit score means you’ll pay about $10,000 more for the car over the life of the loan than someone with a good credit score.

Paying interest on loans may be unavoidable as most people cannot buy a car or a home without a loan. But paying the highest interest rates because of a bad credit score means you are wasting your hard earned dollars to make the lending institution richer. Sirach 20:12 is the best verse I can think of in this example, “A man may buy much for little, but pay for it seven times over.”

And interest rates on car loans aren’t the only place where your credit score has either a negative or a positive impact.  The same also applies to rent, mortgages, credit cards, furniture loans, utility deposits (water, electric, cable), job applications and any other financial transaction you may enter into.

You have both a credit SCORE and a credit REPORT. A credit score Is a 3-digit number that encompasses everything that is on your credit report. Here’s what your credit score includes and what you should focus on when trying to improve your credit score.

Payment history makes up 35% of your score. Lenders want to know whether you will make payments on time and the most obvious indicator of that is how you have paid in the past. This is one of the most important factors in a credit score.

The total amount you owe makes up 30% of your credit score. Credit scores incorporate a metric called “credit utilization,” which is the ratio of your credit card balances to your credit limits. A lower ratio is better than a higher one, so using only a portion of your available credit is best.

The length of your credit history accounts for 15% of your score.  In general, a longer credit history will increase your credit score. How long your credit accounts have been established, the age of your oldest and newest accounts and the average age of all accounts are considerations.

Another factor, which accounts for 10% of your score, is the types of credit in use—your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans.

New credit counts for 10% of your score. Research shows that opening several credit accounts in a short period of time represents a greater risk—especially for people who don’t have a long credit history.

While your credit score is a number representing the factors listed above, your credit report contains more details. It lists all locations where you have lived; all your alias’s (with and without a middle name, initials or maiden name).  

It includes all of your credit cards, store cards, mortgages, car loans and all other loans and if you paid these on time, late or if you are delinquent. It also includes all open as well as closed accounts and any inquiries from potential lenders. Items in collection are included as are public filings.

Americans are entitled to one free credit report within a 12-month period from each of the three credit bureaus (Equifax, Transunion, and Experian). The three credit bureaus run Annualcreditreport.com, where users can get their free credit reports.

If you receive a copy of your credit report and find an error you should dispute the error formally via a certified letter.  Details and a sample letter can be found at the Federal Trade Commission Consumer Information website. According to the FTC, approximately 25% of credit reports contain at least one error, so it is important for you to check your credit report regularly.

In order to improve your credit score, you’ll need a baseline against which to judge your performance, so find out what your credit score is and try to do it for free. Credit scores are available as an add-on feature of the credit report for a fee. This fee is usually around $10, as the FTC regulates this charge, and the credit bureaus are not allowed to charge you an exorbitant fee for your credit score. Many banks, financial service companies, identity monitoring organizations, credit card companies and credit unions offer their customers a free credit report.

Two-thirds of people haven’t checked their credit score in the past year, according to the National Foundation for Credit Counseling, which means this simple act is a step in the right direction.

Our advice to you is to keep track of your credit report and be sure any errors are reported as soon as you find them.  And stay up to date with your credit score. If it is excellent, celebrate! If it’s bad, take steps to improve it by getting current with your bills and keeping them current.