Bad credit loans: How much does bad credit cost me?

June 27, 2018 - 6 min read

In this article:

How do you know if you can get a “prime” loan, or if you need bad credit loans instead?

  • If your FICO puts you into the “poor” credit range, you’ll probably need non-prime financing
  • You may even need bad credit loans if your score is “fair”
  • Recent events like foreclosures, bankruptcies, charge-offs, or collections make borrowing difficult

Sometimes, increasing your credit score by a single point can boost you into a higher tier and save you thousands.

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Credit scores for prime loans

There is no a commonly agreed definition for the term, “prime loan.” Each lender is free to set its own standards for loans it calls “prime.”

But the phrase usually means a loan that gives the best possible deal to a consumer. It usually comes with low-interest rates and sometimes other privileges.

There’s an exception to that “best possible deal” description. Some lenders may offer super-prime loans, and then the best possible deals go to those borrowers. But any prime loan is, by definition, an attractive one.

What scores qualify for prime loans?

FICO is the company behind the most widely used credit scoring technologies. It categorizes credit scores thus:

  • 800+ — “Exceptional.” Surprisingly, 20 percent of Americans have a score of 800 or higher. And 1 percent have one of 850, which is the highest possible. Only 1 percent of those with an 800+ score is likely to default on a loan so lenders love these borrowers, and can afford to give them exceptional deals
  • 740-799 — “Very good.” You’re still way above average and there’s only a 2 percent chance of your defaulting. So lenders still love you and almost all are likely to see you as a candidate for a prime loan. Twenty-three percent of consumers fall into this group.
  • 670-739 — “Good.” There’s an 8 percent chance of your defaulting on a loan, which means only some lenders are likely to see you as qualifying for a prime loan. Twenty-four percent of the population falls into this group.

Related: What credit score do you need for a mortgage?

It’s worth noting that most of us have dozens of different credit scores. That’s because there are different providers of scoring systems, different credit bureaus and different industry-specific versions of scoring systems. So, for example, an auto lender might use a proprietary, tweaked version that is better at predicting defaults on auto loans.

On top of that, some lenders have stuck with old “legacy” versions that will throw up a different score from more modern systems. This means you shouldn’t assume that the score you get from a credit score service will be the one seen by a prospective lender.

Who gets bad credit loans?

You’d think bad credit loans would only be offered to those with really low credit scores. But some lenders will offer those loans even to those with fair credit scores. With a larger down payment, an applicant with a credit score down to 620 can still get a Fannie Mae or Freddie Mac mortgage.

Here’s how FICO defines the two lower ranges:

  • 580-669 — “Fair.” Twenty-eight percent of those in this score range will default on loans, and they make up 16 percent of the population. So lenders are wary. If you shop around, you may find a sympathetic borrowing source who will lend to you on better terms than those for a bad credit loan. But there are no guarantees
  • 579 and lower — “Poor.” More than 60 percent of borrowers in this group default on loans, and they make up 16 percent of the population. Faced with those odds of default, most lenders will automatically decline applications. Those that accept are bound to demand eyewatering interest rates to cover their losses

Related: Solve these 3 problems and improve your credit score fast in 2018

As FICO puts it, “The promising news for this group is that there are opportunities to improve one’s credit score.”

Do you have a thin file?

Many people have low scores through no fault of their own. Some had a run of bad luck: a period of unemployment or sickness, perhaps.

Others simply have too little information in their credit reports for scoring algorithms to properly calculate their creditworthiness. The industry calls this having a “thin file.”

And it can be a particular problem for young people who’ve yet to get around to borrowing much. It can also affect older folks who’ve not borrowed over the last few years. But non-borrowers of any age can be affected.

Related: Catch-22 (You need credit to get credit, here's how to do it)

This can feel like Catch-22: You can’t borrow without an okay credit score and you can’t get an okay credit score without borrowing. A good place to start to build your credit can be a secured credit card. You have to pay a deposit to the card issuer and can then charge purchases up to your deposit amount.

And you may have to pay interest when you’re “borrowing” your own money. But, providing your card reports to the three big credit bureaus, your score should rise quite quickly.

Cost difference between prime and bad credit loans

The higher your credit score, the less you’re likely to pay for all your borrowing. That applies across the board: from mortgages to credit cards and from auto loans to home equity lines of credit.

As you can imagine, the cumulative effect of a lower score over a lifetime adds up. Some could find themselves down a hundred thousand dollars over that period. If you’re a big borrower, make that hundreds of thousands.

How your score affects your mortgage costs

FICO has a calculator that lets you work out the different costs for a new mortgage depending on your credit score. The following calculations are based on mortgage rates in mid-June 2018, but they’ll likely have changed since then.

Related: Raise your FICO 100 points in 2018 and save big on everything

Credit bureau Experian reckoned in January 2018 that the national average mortgage debt was $201,811. So let’s assume someone’s borrowing $200,000 with a 30-year, fixed rate mortgage. The calculator says someone with a 760-850 score might get the following deal:

  • A rate of 4.322 percent APR
  • Monthly payments of $992
  • Total interest paid over 30 years: $157,238

For the same loan, someone with a score in the 620-639 range (anyone with a lower score is very unlikely to be approved) would perhaps be offered this deal:

  • A rate of 5.911 percent APR
  • Monthly payments of $1,188
  • Total interest paid over 30 years: $227,565

In other words, the borrower with the lower score would throw away over $70,000 in extra credit charges over the lifetime of her loan.

Auto loans and others

But it’s not just mortgage payments that are affected by a score. FICO says that someone with excellent credit borrowing $10,000 as a 60-month auto loan could pay $1,076 in interest over the five-year term. But the same loan would cost someone with a score in the 500-589 range $4,620 in interest — over four times as much!

Related: What is a good FICO score?

Suppose you have eight auto loans during your life. You’d be down nearly $30,000. And, of course, it’s not just mortgages and car loans. You’ll be paying more for every dollar you ever borrow — and, perhaps, more on your rent and insurance premiums.

Average credit scores in the US

Average credit scores probably don’t matter to you much. You’re mainly interested in your own.

But Time Money published an April 2017 analysis by age group that lets you know how you’re doing by comparison with your peers:

  • 18-29 years old: 652
  • 30-39 years old: 671
  • 40-49 years old: 685
  • 50-59 years old: 709
  • Age 60+: 743

The average score for all Americans hit 700 in 2017 for the first time ever.

Young people’s lower scores

Why are younger people doing less well? It’s probably not because they’re fickle.

To start with, they may have thin files. But they also won’t yet have a high median age for their open accounts, which makes up 15 percent of a FICO score.

And they may not have as good a “mix” of revolving credit (mostly store and credit cards) and installment loans, such as mortgages, auto loans and so on. That mix makes up 10 percent of a FICO score.

No matter what your age, having a higher score can save you serious money. It’s worth taking this stuff seriously. You don’t want to live your whole life burdened with bad credit loans.

Time to make a move? Let us find the right mortgage for you

Peter Warden
Authored By: Peter Warden
The Mortgage Reports Editor
Peter Warden has been writing for a decade about mortgages, personal finance, credit cards, and insurance. His work has appeared across a wide range of media. He lives in a small town with his partner of 25 years.