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What It Costs Long Term to Have a Poor or Mediocre Credit Score

If you need an example of exactly how much a credit score can matter, let’s examine how these numbers affect two friends, Emily and Karen.

Both women got their first credit card in college and carried an $8,000 balance on average over the years. (Carrying a balance isn’t smart financially, but unfortunately, it’s an ingrained habit with many credit card users.)

Emily and Karen also bought new cars after graduation, financing their purchases with $20,000 auto loans. Every seven years, they replaced their existing cars with new ones until they bought their last vehicles at age 70.

Each bought her first home with $350,000 mortgages at age 30, and then moved up to a larger house with $450,000 mortgages after turning 40.

Neither has ever suffered the embarrassment of being rejected for a loan or turned down for a credit card.

But here the similarities end.

Emily was always careful to pay her bills on time, all the time, and typically paid more than the minimum balance owed. Lenders responded to her responsible use of credit by offering her more credit cards at good rates and terms. They also tended to increase her credit limits regularly. That allowed Emily to spread her credit card balance across several cards. All these factors helped give Emily an excellent credit score. Whenever a lender tried to raise her interest rate, she would politely threaten to transfer her balance to another card. As a result, Emily’s average interest rate on her cards was 9.9 percent.

Karen, by contrast, didn’t always pay on time, frequently paid only the minimum due, and tended to max out the cards that she had. That made lenders reluctant to increase her credit limits or offer her new cards. Although the two women owed the same amount on average, Karen tended to carry larger balances on fewer cards. All these factors hurt Karen’s credit—not enough to prevent her from getting loans, but enough for lenders to charge her more. Karen had much less negotiating power when it came to interest rates. Her average interest rate on her credit cards was 19.9 percent.

Credit Cards

Emily

Karen

Credit score

760

660

Interest rate

9.90%

19.90%

Annual interest costs

$792

$1,592

Lifetime interest paid

$39,600

$79,600

Karen's penalty

$40,000

Emily’s careful credit use paid off with her first car loan. She got the best available rate, and she continued to do so every time she bought a new car until her last purchase at age 70. Thanks to her lower credit score, Karen’s rate was three percentage points higher.

Auto Loans

Emily

Karen

Credit score

760

660

Interest rate

4.25%

8.25%

Monthly payment

$371

$408

Interest cost per loan

$2,235

$4,475

Lifetime interest paid

$17,880

$35,804

Karen's penalty

$17,924

The differences continued when the women bought their houses. During the ten years that the women owned their first homes, Emily paid $68,000 less in interest.

Mortgage 1 ($350,000)

Emily

Karen

Credit score

760

660

Interest rate

4.38%

5.38%

Monthly payment

$1,749

$1,961

Total interest paid (10 years)

$139,057

$173,222

Karen's penalty

$34,165

Karen’s interest penalty only grew when the two women moved up to larger houses. Over the 30-year life of their mortgages, Karen paid nearly $200,000 more in interest.

Mortgage 2 ($450,000)

Emily

Karen

Credit score

760

660

Interest rate

4.38%

5.38%

Monthly payment

$2,248

$2,241

Total interest paid (30 years)

$359,319

$406,807

Karen's penalty

$98,338

Karen’s total lifetime penalty for less-than-stellar credit? More than $190,000.

If anything, these examples underestimate the true financial cost of mediocre credit:

  • The interest rates in the examples are relatively low in historical terms. Higher prevailing interest rates would increase the penalty that Karen pays.
  • Karen probably paid insurance premiums that were 20 percent to 30 percent higher than Emily’s, and she might have had more trouble finding an apartment, all because of her credit.
  • The examples don’t count “opportunity cost”—what Karen could have achieved financially if she weren’t paying so much more interest.

Because more of Karen’s paycheck went to lenders, she had less money available for other goals: vacations, a second home, college educations for her kids, and retirement.

In fact, if Karen had been able to invest the extra money she paid in interest instead of sending it to banks and credit card companies, her savings might have grown by a whopping $2 million by the time she was 70.

With so much less disposable income and financial security, you wouldn’t be surprised if Karen also experienced more anxiety about money. Financial problems can take their toll in innumerable ways, from stress-related illnesses to marital problems and divorce.

So, if you’ve ever wondered why some families struggle while others in the same economic bracket seem to do just fine, the answers typically lie with their financial habits—including how they handle credit.

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