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Low Credit Scores - Higher Interest Rates, More Money Spent on Interest

Low Credit Scores Cost You More in Higher Interest Rates

Last Updated: February 26, 2016

According to a recent article in the Wall Street Journal, millions of people have been declined for loans despite the Federal Reserve's efforts to encourage more lending and home buying. Consumers lucky enough to have a high credit score made up 90 percent of all new mortgages in 2013. That comes as a slap in the face to the ever growing number of Americans with poor credit and this number is increasing every month.

The percentage of all U.S. consumers that have a FICO score in the range of 550 to 699 is the highest since 2006. To put that in perspective, a borrower with a FICO score below 700 will have to pay a higher interest rate and will have a harder time getting approved for a loan. What does that means in the long run? The lower your credit score, the higher the interest rate you will get on a loan, and the more money you will be paying in interest over the life of the loan.

Interest Paid on Car Loans

Interest rates on car loans vary significantly based on the borrower's credit score. Currently, borrowers with a FICO score of 740 or higher will pay 3.2 percent in interest, whereas borrowers with a FICO score of 680 to 739 will pay an average of 4.5 percent. Borrowers with scores lower than 680 can see interest rates from 6.5 to 12.9 percent. The difference can really add up:

As the above example shows, a person with the lower credit score is going to pay over $2,700 more for the exact same car. Unfortunately, roughly 44 percent of all car loans during the first quarter of 2013 were given to subprime consumers, meaning those with scores lower than 680. According to Experian, this was up nearly 6 percent from last 2012.

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Interest Rates on Credit Cards

You would think after the economic collapse in 2008, getting a credit card would be difficult. Quite the contrary. In fact, qualifying for a credit card has become easier for consumers who have less than perfect credit. But, getting these cards will come at a cost. Rates for borrowers with a lower credit score will be as much as seven percent higher than borrowers with excellent credit.

According to the latest study by CardHub.com, consumers with a FICO score of 720 were charged an average interest rate of around 12.9 percent, borrowers with a FICO score of 660 to 719 paid 17.1 percent, and borrowers who's scores were below 659 paid 20.3 percent on average. What does that mean in terms of more money spent?

Having a lower credit score and paying a higher interest rate on a credit card will cost over $1,200 more in interest.  That is money that could be spent on food, vacation, or education.

Mortgages

Out of all the types of consumer loans, mortgages remain the hardest to get, especially if you have poor credit. If you have a FICO score of 620 or less, you are unlikely to qualify for any type of mortgage loan. According to Informa Research Services, a borrower with a FICO score of at least 760 will be approved for a loan with an average interest rate of 3.3 percent.

At the other end of the spectrum, a borrower with a FICO score of 620 can expect to get a rate of around 4.9 percent. On a 30-year mortgage, that equates to over $3,300 more the person with the lower score will pay in a year. In 30 years, that is almost $100,000!

So, what is the moral of the story? Having negative items on your credit report not only lowers your credit score, it costs you more money in interest payments. The lower the score, the higher the interest rate you are going to get on your next car loan or credit card. The percentage rates may not appear that significant at first, but when you take a look at the overall picture and figure out how much more you are paying in interest, the amount really adds up after a few years.

Before you apply for that next credit card or car loan, check your credit score. Take the necessary steps to get the negative information off of your credit report and you will see your credit score rise. This effort will pay off down the road when you qualify for that lower interest rate.

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