How Bad Credit Can Hurt You Financially
Most people understand that having bad credit can negatively affect their ability to borrow at a decent interest rate. But a recent study conducted by Nerd Wallet shows that most people don’t fully understand how a bad credit score can affect their everyday lives. And while it’s true that having bad credit can make your life more difficult, when you combine bad credit and a high debt level, it gets even worse.
Here are some of the ways that having a lot of debt AND a bad credit score can hurt you financially.
More Debt Equals More Interest
You might know that, when you have bad credit, you’ll pay a higher interest rate. But did you also realize that, when you apply that higher interest rate to a higher debt load, it amounts to more money being pulled out of your pocket? In other words, the higher your debt load, the more interest you will be charged – and all this comes at a higher interest rate because of your low credit score.
Here’s an example of how a combination of high debt and bad credit can affect your financial life when it comes to credit cards. Imagine that your credit score isn’t optimal, and your credit card company charges you 25% interest on a $1,000 balance. If you pay $100 a month, you will pay off the card in a year, having paid $133.22 in interest.
On the other hand, if you have a $10,000 credit card balance with the same high interest rate, your minimum payment is $417, and over three years, you will pay $4,002 in interest. That’s a huge chunk of change!
That Home Will Cost You More
Another way having both a high level of debt and a low credit score can hurt you financially is if you decide to purchase a home. Mortgage lenders look at a few things when deciding what type of loan terms to extend to borrowers, one of which is the debt-to-income (DTI) ratio. If you owe too much debt in comparison with your monthly income, the lender will consider you as having a high DTI ratio. That alone can cost you a higher interest rate. Adding bad credit into the mix will cause the lender to offer you a sky-high interest rate – if they decide to offer you a loan at all.
What is a high DTI ratio? Most mortgage lenders consider anything above 43% as a no-go when it comes to issuing loans. To figure your DTI, add up all of your monthly bills and divide it by your income (before taxes are taken out).
When lenders look at a borrower’s DTI, they separate the monthly expenditures into two columns – “necessary” expenses such as rent and utility payments go in one column, and “unnecessary” expenses like credit card bills go in another. Potential borrowers with high expenses in the unnecessary column risk not getting the loan – or if they do, they will pay for it with a much higher interest rate.
Your Credit Score and the Ripple Effect
Did you know that if you carry a lot of debt – more than 30% of your available debt – it will negatively affect your credit score? That could be one of the reasons your credit score is low.
Remember, a low credit score will do more than keep you from getting a loan or a new credit card:
- Auto insurers look to your credit score to determine your insurance premium.
- Landlords look at your credit score to determine whether or not to rent to you – and even if they do rent to someone with a lower score, they will likely ask for a higher deposit.
- Utility companies usually ask for a deposit from people who have low credit scores.
- Many companies look at job applicants’ credit scores to assign a risk value to them – and that can determine whether or not you get the job.
As you can see, high debt can lead to a lower credit score, and that can lead to all kinds of negative financial repercussions that will end up costing you more money.
Another way the combination of high debt load and low credit score can cost you is in missed opportunities. Someone with a low score and high debt will not have the same financial opportunities as those with good scores and low debt. For instance, some credit cards offer an introductory 0% APR on the first year for balance transfers. That’s a great way to quickly pay off debt because the interest payments are eliminated for a year. But here’s the catch: Typically only those with good credit and a low DTI can apply for these cards.
High-Interest Debt Holds You Back
You likely have dreams and want to work toward them to better your life. But if you are saddled with too much debt – and a high-interest rate on that debt due to bad credit – chances are that you are going to have to put those dreams on hold. That’s because the payment on a high-interest debt is higher, and if you have a lot of it, most of your income is likely going toward paying it off instead of pursuing your dreams.
In other words, your high-interest debt could be costing you the future you dream of.
After reading the illustrations that having a high debt load and a low credit score can negatively affect your financial life, you likely have other questions and concerns. If you are feeling trapped because of a low credit score and a high debt load, you should know that there is hope. The friendly advisors at American Credit Foundation are here to help. Simply give us a call, and let us speak with you about your options for getting back on track financially.