As the world becomes more digital and cash-free, good credit is more important than ever. But do you have it?
There are a lot of things these days you simply cannot do easily without a credit card, such as renting a car. Although you can qualify for a mortgage loan with less-than-perfect credit, it is not the best financial situation.
We always hear how important having good credit can be to your personal finances, so I decided to crunch the numbers and find out just how important it is for a variety of situations.
The universally accepted standard in credit scores is the FICO score. These scores range from 300-850 with the higher the score, the better. According to myFICO.com, a score of 760 or above is considered to be very good, and will generally qualify you for the best rates available-or very close.
Buying a home
We all know if your credit is bad enough, you simply can't get a mortgage. However, the quality of your score is important as well. Let's look at three scenarios to see how a 'good' or 'bad' score will affect your wallet.
First, if a home buyer has a FICO score of 760 (considered top-tier), he or she could expect a 30-year mortgage rate of 3.9% as of this writing. A homebuyer with a good, but not great score of 690 could expect a rate of 4.29%; finally, a buyer with a score of 620 (the minimum) can expect a rate of 5.48%, and may possibly have to get an FHA loan, which carries with it additional expenses.
The difference in monthly payments between these three rates is significant. From best to worst, these hypothetical homebuyers would pay approximately $1,179, $1,235, or $1,416 on a 30-year mortgage of $250,000, depending on which of the three credit scores they currently have-a difference of almost $300 a month!
Buying a car
When buying a car, good credit is even more important. In the eyes of lenders, there are two types of assets you can buy: appreciating assets (a house) and depreciating assets (a car, boat, electronics, etc.). With an appreciating asset, a bank figures that it can at least take back the asset, sell it, and recoup its money. With a depreciating asset the lender isn't as confident that it can repossess the asset and make its money back, so credit plays a much bigger role.
Let's say you want to buy a $30,000 car. Using our three credit scores of 760, 690, and 620, the difference between loan rates is significant. On a 48-month loan, these customers can expect rates of 3.2%, 4.6%, and 10.9%, respectively. This translates to monthly payments of $667, 685, and $773. In other words, the buyer with poor credit will end up paying over $5,000 more over the life of the loan!
There is a long list of items that become much more difficult when you have bad credit. For instance, a lot of employers do a credit check, and will refuse employment to those with lots of charge-offs and defaults. Many apartment communities will not rent to anyone with a credit score below the mid-600s, and those that will rent to low-credit tenants may ask for a hefty additional security deposit.
Credit cards are another issue. With secured credit cards, virtually anyone can obtain a credit card if they can put up a security deposit. However, the difference is interest rates and benefits. According to Bankrate.com, the average APR for credit cards is currently 15.38%, but rates of up to 36% are common for those with bad credit. A poor credit score will almost certainly exclude a consumer from the popular "perks" credit cards that offer rewards such as frequent flyer miles.
Make your move
Life is just easier with good credit, and hopefully this discussion has provided some perspective on just how much better it can be. A quick calculation involving our mortgage example reveals that our hypothetical homebuyer with a 620 FICO score will pay more than $85,000 in extra interest over the life of a $250,000 mortgage than a buyer with a 760.
I don't know about you, but I can think of a million better ways to use $85,000 than just handing it over to a bank!