Long Term Consequences of a Poor Credit Score
Perhaps the best way to explain the long term consequences of mediocre or poor credit score is to give you an example that compares the way two different women have handled their credit over a life time.
Let’s take the example of two women – Joan and Kelly – who for the sake of our little example have led identical lives.
Both women:
- have exactly the same income
- carry an annual balance of $8000 on their credit card every year
- financed their cars after graduation with $20,000 car loans and replaced the vehicle every seven years until the age of 70.
- Bought her first home with $350,000 mortgages at age 30 and then bought a new larger house that cost $450,000 at age 40
- Have never been turned down by a credit card company
However despite their absolute similarities by the end of their lives Kelly ends up paying hundreds of thousands more in interest, charges and fees than Joan. How could this possibly happen?
The Story of Joan
Joan was always careful to pay all her bills on time, all the time and made a special effort to pay more than the minimum balance owed on all credit cards and debts.
Lenders responded to her responsible use of credit by offering her more credit cards at better rates and terms. They also increased her credit limits regularly as they always knew she would pay. The high credit limits acquired by Joan also allowed her to spread her credit card balance across several cards, which gave her a very high score.
Joan’s high credit score put her in an excellent bargaining position with the credit card companies. Whenever a lender tried to raise her interest rate she would either threaten to transfer her balance to another card or actually do it. As a result, Emily sailed through life with an average low interest rate on her cards of 9.9%.
The Story of Kelly
Kelly, by contrast did not always pay on time, frequently paid the minimum amount due on the card or less and had a habit of continually maxing out all the cards she had. This discouraged lenders from increasing her limit or offering her new cards.
Although the two women in theory owe the same amount of money on average, Kelly tended to carry larger balance on fewer cards. This tended to hurt her credit, not enough to prevent her from actually getting a loan but just enough for lenders to take advantage of her by charging her more.
Karen’s average interest rate on her credit cards was a whopping 19.9 percent – 10% more than the interest on Joan’s credit cards, which put her in the poorhouse by the end of her life.
Here is an example of what the two women’s finances look like when compared side by side.
Credit Cards
Joan Kelly
Credit Score 750 650
Interest rate 9.9% 19.9%
Annual Interest Costs $762 $1592
Lifetime Interest Paid $39,600 $79,600
Kelly’s Total Penalty $40,000
As you can see by the above example, when it comes to credit cards, Kelly’s low credit score required that she pay double the interest rate and twice as much annual interest which cost her $40,000 over the long term until the age of 70.
Unfortunately a similar scenario repeats itself when we compare the two women’ history of auto loans.
Auto Loans
Joan Kelly
Credit Score 750 650
Interest rate 5% 8%
Monthly Payment $377 $406
Lifetime Interest Paid $21,666 $34,563
Kelly’s Total Penalty $13,487
Once again Kelly’s low credit rate cost her a bundle, including a monthly payment that was higher than Joan’s and almost one third more lifetime interest than credit-savvy Joan.
The differences between the two women are also evident in the way they both handled their mortgages when they both bought their first homes.
First House Mortgage (at age 30)
Joan Kelly
Credit Score 750 650
Interest rate 5.5% 7.735%
Monthly Payment $19,87 $2,417
Ten Years of Interest Paid $174,760 $243,020
Kelly’s Total Penalty $68,261
As you can see, over the span of the decade, hardworking and harassed Kelly paid $68,261 more in interest than credit- smart Joan.
At age 40 when both women decided to buy new houses Joan decided to buy a slightly larger house because she could afford it. This is the only time in her life when Joan’s interest penalty grew …
Second House Mortgage (at age 40)
Joan Kelly
Credit Score 750 650
Interest rate 5.5% 7.735%
Monthly Payment $12,555 $3,108
30 Years of Interest Paid $469,818 $668,894
Kelly’s Total Penalty $199,894
Although Joan’s interest rate grew you can also see that Kelly paid close to $200,000 more than Joan just to live a relatively similar life to hers.
Kelly’s mediocre credit (which is not even that low!) actually cost her in other ways as well –
• Higher interest rates probably substantially increased the penalties that Kelly paid just to live in the same manner as Joan. During times when interest rates rose, her costs even higher than the $199,894 (that are calculated on low 3% interest rates in the example.)
• Kelly likely also paid insurance premiums that were 20 to 30% higher than Joan’s thanks to her skimpy credit rating as insurers equate low credit scores with a high risk client
• Kelly probably had to spend more time working to pay off her lenders thus finding herself leading a more stressful life and missing career opportunities
• As Kelly’s paycheck mainly ended up in the hands of lenders she probably had less money for a vacation, her kid’s education and retirement. She probably worked twice as hard to maintain the same standard of living as Joan and experienced more stress in general.
• With less disposable income and more debt, it would not be that surprising if Kelly experienced more stress than Joan and therefore illness and maybe even hospital bills that were difficult for her to pay
…and if Kelly had invested that $200,000 that was spent paying interest on loans and credit cards she might have been worth two million dollars by the time she was seventy years old!
Hopefully the above example truly explains why some individuals do well while others really suffer and struggle even though they make the same amount of money and convinces you to start taking better care of your credit score as of today!