Low Credit Scores hurt more than you think

If you are struggling with a low credit score, you already know that it results in high credit card rates and real challenges in obtaining other kinds of credit.  But the problem goes beyond this.  People with low credit scores pay higher interest rates on almost every type of loan.  The reason given by lending institutions is that the cost of lending to people with low credit scores is higher than the cost of lending to people with high credit scores.

A recent article from SmartMoney.com reported on some of the problems faced by people with less than perfect credit.  A perfect credit score is 850.  Almost half of all consumers have a score below 700, with 1/3 in the 550 to 699 range.  Many of these people will have problem getting credit; and if they do, it will more than likely result in a percentage rate that is higher than if your score is 725 for instance.

The numbers are frightening.  According to Experian, 44% of all car loans issued went to persons with “subprime” credit, (less than 680 credit score.)   The interest rate sliding scale goes like this:
Credit Score    Avg. Interest Rate    Additional Interest paid on a $10,000, 5-year loan
740+                    3.2%                                                        —
680-739                4.5%                                                 $   351
Below 680             6.5-12.9%                                        $2,760

The story for credit cards is way worse.  If your score is over 720, you paid an average interest rate of 12.9% for a new credit card issued in 1st qtr 2012.  For scores between 660 and 719 a whopping 17.1% and 620 to 659, the figure jumped to 20.3% on average.

Although lenders may have and probably do have, a valid point when discussing the cost of lending money to consumers with low credit scores, the process becomes a self-fulfilling prophecy.  Because people with low credit scores generally have a lower income, that means they have less available cash with which to pay the higher rates.  It becomes almost impossible to improve your credit score when you’re paying more and making less.  It’s the classic Catch-22.

So the question is, what can you do if your credit score is less than stellar?
Cut unnecessary spending.  It will take a few mental adjustments, but try this…it took a while to get into debt and a low credit score, it’s going to take a while to get out.  The problem will not be fixed in a month.  It’s a war, not a battle.

Start clipping coupons.  Yes, we mean this literally, but also figuratively. Look for ways to save money around the house.  Shop more often at discount stores; keep an eye out for sales on products you use a lot.  Do you waste electricity?  You’d be surprised how much turning off a few lights and turning off your computer at night can save you.
Investigate a loan consolidation.  Would you save some money on a monthly basis and possibly overall if you consolidated your bills?  See if your local bank can help you.  It’s worth the time to investigate.

Pay off all Credit on time.  If you take out a short term loan such as a payday loan, pay it off on time.  This not only saves you additional fees, it will help you to lower your credit score.  Any credit you pay off on a timely fashion will, over time, improve your credit score.

Is it fair that people with low credit scores get charged more?  Maybe, maybe not, but it is the world we live in.  Do your best to pay back any borrowed money according to the terms of the loan.  As we now know, it’s cheaper in the long run.

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