It’s not unusual for consumers to work to improve their credit scores. Most of us know that higher credit scores are better than lower credit scores. What I think is missing, to some extent, is a better understanding of the quantified value of a higher score relative to a lower score. Yes, 750 is better than 650. But, what does that mean to me as far as my credit opportunities?
Let’s take two fictitious people. One will be Jeff and the other will be Danielle. Danielle pays her bills on time, only applies for credit when she needs it, and maintains respectable balances on her credit card accounts. Jeff, on the other hand, isn’t quite as responsible with his credit. He has some late payments on his credit reports and runs up larger balances across several cards. Danielle’s credit scores are all pretty close to 800. Jeff’s credit scores hover around 650.
What are Danielle’s Credit Options?
Simply put, Danielle’s credit option are extensive and competitive. Applicant’s with scores at or near 800 are considered to be almost completely void of credit risk. That means lenders will be making very competitive offers, perhaps even their most competitive offer.
Auto Loans: It would not be unheard of for Danielle to get an offer of zero percent interest from a captive auto lender. The captive lender is the lending arm of the manufacturer. Think Ford Motor Credit, Toyota Financial, Honda Financial Services, and Chrysler Capital for example. Some dealerships will offer you zero percent financing on certain makes and models, but only for people with excellent credit like Danielle. In in the non-captive lending scenario Danielle can expect to get an auto loan offer well below five percent.
Mortgages: Applicants with scores near 800 are going to get the best mortgage interest rates. As of November 2018 the interest rate on a 30-year fixed rate mortgage loan was around 4.5% for people with stellar credit scores.
Credit Cards: Credit card interest rates are around 17% on average but they can dip below 10% but only if your credit scores are very strong. And, Danielle can expect to receive numerous credit card offers in the mail with balance transfer offers and a zero percent interest grace period.
Apartments and Utilities: Danielle will likely fly through the tenant screening process and it’s doubtful she’ll be asked to place a deposit before she moves in. And, utility companies likely will not ask for a deposit when she starts new services.
What are Jeff’s Credit Options?
Jeff’s options are limited because of his 650 credit scores. Applicant’s with scores at, near and below 650 are considered to be of elevated credit risk. They will have fewer borrowing options and those options will be more expensive. And, some lenders simply won’t do business with them at all, under any condition.
Auto Loans: Jeff will not qualify for zero percent financing. And, he may have to choose a subprime auto lender as an alternative to his bank or credit union. He will likely have an interest rate around 15%, according to Informa Research, unless he’s able and willing to put down a very large down payment.
Mortgages: Applicants with credit scores near or below 650 are actually closer to being denied than they are to being approved. As of November 2018 the interest rate on a 30-year fixed rate mortgage loan was over 6% for people with scores in the low 600s. And while a 6% interest rate may sound good, over the life of a $500,000 mortgage loan Jeff will pay about $180,000 more in interest than Danielle.
Credit Cards: Jeff’s credit card options are limited. Some card issuers don’t have a product for scores as low as Jeff’s scores. Still, he’ll be able to open a credit card but his credit limits will be lower than Danielle’s limits. And, his interest rates will be subprime rates, which can be well into the 20-something range.
Apartments and Utilities: Because you don’t have a right to an apartment, Jeff’s poor credit will lead to either a denial of housing or a large deposit. And, while he does have the right to start new public utility services, he will almost certainly be asked to place a deposit before services are started.
What’s The Bottom Line?
The bottom line is that it’s expensive to have poor credit scores and your options are limited. You may even have to seek financing from the so-called second tier lenders, like payday lenders and asset lenders. The rates on those type of offers, when annualized, can be as high as several hundred percent. It’s in your best interest to work to improve your scores as good scores are just as financially rewarding as choosing the right stock or mutual fund.