The High Cost of Bad Credit

Establishing a good credit history comes with a lot of benefits, but one of the most important is that it can save you money.

There is a high cost of bad credit, and it’s not just evident when you borrow money. It can also hurt your chances of obtaining affordable housing, inexpensive insurance, or even getting a coveted job.

Here’s what you need to know about how bad credit can affect you and many of the costs you can avoid by improving your credit score.

What does bad credit look like?

Both beauty and bad credit are in the eye of the beholder. While FICO has set numbers for the different credit ranges, some lenders may have their own internal criteria to determine whether you have bad credit.

That said, FICO sets the credit score ranges as follows:

• Bad credit: 300 to 579
• Fair credit: 580 to 669
• Good credit: 670 to 739
• Very good credit: 740 to 799
• Exceptional credit: 800 to 850

This means that if have below a 580 credit score, you’re generally considered to have bad credit. Remember, though, that a specific lender may consider that a fair credit score, depending on its own credit risk profile.

What are the costs of bad credit?

Having bad credit can affect you in several ways, some of which you may not have anticipated. Here are some of the biggest ways having bad credit can cost you money.

Higher interest charges

If you have a bad credit score, getting approved for a loan or credit card can be difficult. If you do get approved, though, you can generally expect to pay much higher interest rates than if you were to have a higher credit score.

Some bad credit personal loans, payday loans for instance, charge triple-digit interest rates. Even on an installment loan that you’re paying back within a year, that can cost you a lot.

With a mortgage loan, the rate difference may not seem wide — your interest rate may be 6% instead of 4%. But over the course of 30 years, it could cost you tens of thousands of dollars if you can’t manage to refinance at a lower rate in the future.

Higher insurance rates

The vast majority of homeowners and auto insurance companies use what’s called a credit-based insurance score to help determine your policy premium. This is primarily because studies have shown that consumers with bad credit tend to file insurance claims more often than people with good or excellent credit.

“It is one among many risk factors considered, along with previous tickets and claims, age, gender, place of residence, and marital status,” says Todd Christensen, an accredited financial counselor and education manager at Money Fit, a nonprofit organization that provides debt relief services.

While a bad credit score generally can’t be used as the sole reason for a rate increase, it can prevent you from qualifying for a lower rate. Depending on the company and the situation, you could end up leaving hundreds of dollars per year on the table.

Limited access to certain financial products

Some financial products require that you have good or excellent credit to qualify. For example, many rewards credit cards, which can offer hundreds or even thousands of dollars each year in rewards and benefits, typically aren’t available to people with bad credit.

Again, you’re not necessarily paying more by not having a rewards credit card. But by missing out on the value they provide, you’re not as well off as you might otherwise be.

You also won’t qualify for other products, such as 0% APR promotional auto financing or unsecured personal loans.

Missed employment opportunities

If you work in finance or for the government, some jobs may require a credit check. If you have bad credit, it could signify that you could be compromised financially if you’re regularly handling money or have security clearance. Depending on your career aspirations and potential pay raise you could get from the job, having bad credit could be devastating.

That said, most employers in other industries don’t typically run a credit check when you apply for a job, so it may or may not affect you.

It’s hard to definitively calculate how much bad credit will cost you over time, but depending on the situation, it could cripple your ability to become financially secure.

Why consumers with bad credit pay more

Lenders use a method called risk-based pricing to determine what to charge on a loan or credit card. People with good or excellent credit typically receive the lowest interest rates because they’ve proven over time that they’re likely to pay back the debt in full.

On the flip side, people with bad credit may have struggled in the past to keep up with their payments. As a result, lenders typically charge higher interest rates to compensate for the added risk they’re taking on working with a bad-credit borrower.

Of course, not everyone with bad credit got there because they’re irresponsible. It can also be a product of circumstances that are out of your control, such as divorce, medical bills, unemployment and more.

But, unfortunately, most lenders don’t have the ability to consider every situation individually, so they rely heavily on your credit score and the information contained in your credit report without the full context.

Learn how to read your credit report here.

Some lenders work with people with bad credit

As previously mentioned, having bad credit doesn’t automatically mean that your application will be denied. There are plenty of lenders that specialize in working with consumers who have bad credit.

That said, remember that you can still expect to pay a high interest rate. Also, with auto and mortgage loans, you may need a much larger down payment. For example, OppLoans offers installment loans with APRs as high as 199%. While the terms are much better than payday loans, it’s still incredibly expensive.

OneMain Financial also offers personal loans with no minimum credit score requirement, and its highest APR is 35.99%. That said, not everyone will qualify, and you may be required to put up collateral to secure the loan.

If you’re looking for an auto loan, Auto Credit Express can connect you with multiple lenders at once who may be able to help you get financing. If you’re looking for a mortgage loan, though, it may be best to learn ways to improve your credit before applying or get a co-signer.

Improve your credit to reduce costs

The best way to cut down the high costs of bad credit is to work on improving your credit score. Doing this can not only help you score lower interest rates, but also give you access to better financial products, home or apartment rentals, and jobs. See how credit history affects renting an apartment.

Here are some steps you can take to establish a better credit history.

1. Check your credit score and report

Before you do anything, you need to know where to focus your efforts. Start by checking your credit score using a free service like Credit Karma or Discover Credit Scorecard. Checking your score can show you where you stand and allows you to keep track of your progress over time.

You can also get a free copy of your credit report from each of the three national credit reporting agencies through AnnualCreditReport.com. With your report in hand, you can review and pinpoint which areas need to be addressed.

2. Look for inaccurate information

It’s possible for a credit report to contain inaccurate, unverified or unfair information, so it’s important to review your reports regularly to make sure there’s nothing incorrect or fraudulent that’s pulling down your score.

If you do find something, you can file a dispute with the credit reporting agencies, who will work with the creditor to verify the tradeline. You can also enlist the help of a credit repair company to do this, but they typically charge a fee for something you can do on your own for free.

And remember that these efforts only work for inaccurate, unverified or unfair information.

“If you have some negative but accurate activities on your credit history and you try to hire a repair company to remove the negative stuff, chances are you will spend more on paying for their services than you would save on interest in the future,” Christensen says.

3. Focus on problem areas

There may be some things you cannot do about your bad credit. For example, if you’ve recently filed bankruptcy or experienced a foreclosure, you likely won’t get that removed.

You may, however, find things you can work on.

“If you have any accounts where your payments are late, get caught up as soon as possible. The late payments will stay in your credit history for seven years, but changing the status to ‘paying as agreed’ is a big boost,” Christensen says.

If you have a collection account or high credit card balance, pay the debt down as quickly as possible. The right steps will depend on what’s on your credit report, so take some time to read through it to know what needs to be done.

4. Consider a credit builder loan

Addressing negative items on your credit report is an important part of improving your credit score, but it’s also essential that you work on building a positive history.

One way to do that is to apply for a credit builder loan. Once you’re approved, the lender typically keeps the loan funds in a savings or certificate of deposit account while you make payments for the loan term.

After you’ve made all the payments, you’ll receive the loan funds, along with any interest they’ve accumulated during the term of the loan.

A credit builder account can help you build your credit because your on-time payments help you establish a positive payment history, which is the most important factor in your credit score.

5. Use a secured credit card

If you don’t already have a credit card you can use, consider applying for a secured credit card. These cards do require an upfront security deposit but can help you establish a positive payment history as you use them regularly and make your payments each month.

Some secured credit cards even offer rewards when you use the card to make purchases. Learn how to use a secured credit card to build credit.

Bad credit can cost a lot, but it doesn't have to be permanent

Having bad credit can cost you a lot over a lifetime, and can make it difficult to achieve financial security and independence. Fortunately, it’s possible to take steps to improve your credit score and give yourself a second chance.

There’s no hard-and-fast rule for how long it takes to improve credit. While some actions, such as getting added as an authorized user on someone else’s credit card or paying down your credit card balance, can have an immediate influence on your score, others can take months or even years to make a big difference.

The important thing is to establish good credit behaviors, which will not only help you improve your credit in the beginning, but also keep it great later.

About the author

Ben Luthi is a personal finance writer who has a degree in finance and was previously a staff writer for NerdWallet and Student Loan Hero.