What you don’t know about credit can cost you — perhaps thousands of dollars.
And, if you’re low-income, having bad or no credit can make you even more financially unstable, according to new research by the Urban Institute.
Let’s look at a person taking out an auto loan who has a subprime credit score below 600 (on a scale of 300 to 850, the highest score being the best). He’s buying a $10,000 used car. The subprime borrower has a FICO credit score between 500 and 589, which qualifies him for an interest rate of 17.548 percent for the 48-month loan. He’ll pay a total of $3,987 in interest.
Meanwhile, a prime borrower with a FICO score between 720 and 850 is offered a rate of 4.896 percent. Total interest paid: $1,031.
“People with no, thin or poor credit are doubly constrained,” says Diana Elliott, senior research associate with the Urban Institute. “They are already among the more economically vulnerable members of society and then have to pay much more to borrow money because of their credit. So, those with the least money pay even more for the goods and services that we all need — cars, appliances, emergency repairs.”
The Urban Institute put together a list of seven common assumptions about credit. How well informed are you? Are the following statements true or false?
1) Everyone has a credit score.
2) You have to be wealthy to have good credit.
3) To build credit, you have to go into debt.
4) Having a lot of credit cards is bad for your score.
5) If you pay all your bills on time, you’ll have a good credit score.
6) Paying rent or having a payday loan, if managed well, can help you build a good credit score.
7) Don’t seek out credit. Inquiries can ruin your credit score.
Every statement is false.
1) Everyone does not have a credit score. Nineteen percent of U.S. adults and 46 percent of people living in low-income neighborhoods don’t have one, according to the Consumer Financial Protection Bureau.
2) Your income is not a factor in determining your credit score, and 3) it’s not necessarily true that to build credit you have to go into debt. “A person with a credit card, who pays their monthly bill in full and on time, will carry no debt from month to month, pay zero percent in interest, and have excellent credit,” said Ricki Granetz Lowitz, chief executive and co-founder of Working Credit, a nonprofit that helps employees improve their credit.
4) The scoring system looks at how you use your available credit — not how many cards you have.
5 and 6) The two myths about paying your bills might have stumped you. While it is true that staying current on your debt obligations is the No. 1 way to achieve an excellent score, a lot of people are paying bills that aren’t reported to the credit bureaus. People who pay their rent, cable and utility bills on time, every month, can easily have no credit, Lowitz points out.
7) A credit inquiry generally has a small impact on your score, typically five to 10 points.
Why should you care about all this if you’ve got great credit? Because helping low-income folks reduce the cost of their borrowing creates economically stable families, and that benefits everyone.
“Nearly 20 percent of the population have no credit score, and 27 percent of those in the credit system have subprime credit,” Elliott said. “This impacts whole neighborhoods and cities, meaning city budgets may devote more resources to helping these individuals, and whole communities may experience resource deficits.”
Employers should definitely care, said Lowitz. “People with poor or no credit, who are great and valued employees, end up being late or absent more frequently than people with good credit — just because they can’t respond quickly to a crisis like a car breaking down on the way to work,” Lowitz said.
Without access to affordable credit, someone who is less well-off may see no alternative than to turn to payday loans, which carry high fees that, when annualized, amount to triple-digit interest rates.
I recently moderated a panel discussion at the Urban Institute on the cost of credit. Watch the video, which includes candid interviews illustrating how confused people are about credit and credit scores.
“People with a thin credit file, especially those living on low or volatile incomes, face fewer choices, higher costs and more obstacles to financial security”, said panelist Bob Annibale, Global Director of Citi Community Development and Inclusive Finance. “But with the kind of counseling and support provided for free by organizations like Working Credit, opportunities such as homeownership, owning a small business or saving for the future can become a realistic goal.”
I’ve often said that credit is evil. I do this to help people curb their use of it. The more you fear credit, the less likely you’ll abuse it. But because we live in a society where your credit history is your financial scorecard, having good credit is still well worth the effort.