The Effect of FICO Credit Scores on Wealth Creation

We all know that a good credit score can result in a better interest rate on loans but you may be surprised to learn that a bad credit score can affect you in ways you might not have thought about.  In addition to paying higher interest rates, a poor credit score can result in higher insurance premiums, denial for employment, or having to pay a security deposit when leasing an apartment or opening a utility account.

According to Fair Isaac, the company behind your FICO score, 35% of your score is based on your payment history; 30% on the amount and type of debt you have, 15% on how long your credit history is, 10% on new credit taken, and the final 10% on the various types of credit you use.  According to Experion, the national average credit score in the U.S. is 736.

Higher Mortgage Interest Rates

FICO and Loan Rate

FICO Score & APR for $150,000 30 Year Fixed Mortgage

In the table to the right, mortgage payments were calculated for FICO scores ranging from a low of 620 to a high of 850 for a $150,000 conventional 30 year fixed rate mortgage.  It is clear to see the lower your FICO score the higher your APR and the more you will pay for your loan.  For instance, let's take a look at someone with a FICO score of 630 versus someone with a FICO score of 780.  You will pay $140 more per month or an additional $50,474 in interest over the life of the loan. Another way to look at this by looking at the lost opportunity to use the money for other purposes like building wealth.  By investing the extra $140 per month, earning 6.5% for 30 years you could end up with $160,940.  Kind of puts a different light on how expensive bad credit can be.

Higher Auto Insurance Rates

According to the Texas Department of Insurance, drivers with the worst credit scores were 1.5 to 2 times more likely to file a claim for both auto and homeowners policies.  They also found that drivers with the best credit ratings were 40% less likely to be involved in an accident.  Someone with a poor credit score is going to pay between 20%-50% more for auto insurance than someone with good credit.  With the national average cost for an annual policy of $1438, that would mean an extra $288-$719 each year for auto insurance.

I recently lost my job and have been late on my bills.  Will my insurance premiums increase as a result of this?

Many states have introduced legislation allowing policy holders to opt-out of the credit based rating system in cases of extraordinary life circumstances that could affect your credit: military deployment overseas, serious injury to self or immediate family member, loss of employment for 3 months or more, death of a child, spouse, or parent, or identity theft.  Contact your insurance agent for details.

Higher Interest Rates on Loans

If you have a poor credit rating you will not qualify for that zero percent financing deal for that new car you are looking at.  You will have to deal with a sub prime lender who may charge interest rates up to 25% adding thousands to the cost of owning a car.

Higher Account Fees/Deposits

Cell phone provider Verizon charges a $400 deposit for new accounts where the customer has a poor credit score.  The deposit is refunded after 12 months provided all payments are made on time.

Utility Companies in Arizona are permitted by law to require residential customers with poor credit scores to pay a security deposit of no more than twice their estimated average bill.

Apartment Rental – States govern how much landlords can charge for security deposits but in general tenants with poor credit scores will pay a higher security deposit.  There are also ways for landlords to get around the limit on security deposits by requiring payment of first and last month's rent in advance for tenants that landlords feel are a risk to skip out and not pay last month's rent.

The good news is that you are not destined for a life of higher interest rates and fees if you have poor credit.

What can I do to improve my credit score?

  • Pay your bills on time
  • Keep oldest accounts open and use occasionally (pay balance in full each month)
  • Keep outstanding credit below 40% on total credit limit
  • The goal is to pay off credit card debt monthly
  • Check your credit report annually and fix errors

As you can see poor credit can not only cost you more each month in higher interest rates and fees but more importantly make it difficult to build wealth. By taking care of your credit score and using credit appropriately, you can literally save thousands of dollars each year that could be used to fund other goals such as a child's education or retirement.

What would you do with money you were able to save as a result of a lower interest rate?  Spend it or save it?

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17 Responses to The Effect of FICO Credit Scores on Wealth Creation

  1. Syed 07/14/2014 at 1:40 pm #

    Nice illustrations on how important your credit score is. Maintaining a great credit score is pretty easy and will give you a lifetime of benefits.

  2. Poor and Broke 09/03/2012 at 9:53 am #

    I have ten-year-old bad credit following several months in hospital and being unable to work for over a year. During this time all my open accounts were closed and charged off and one creditor sued and obtained a judgment.

    During this time I relocated to live with relatives as without income I could not pay rent. Then I returned to work at a new minimum wage job which paid the current bills but did not provide enough income to pay off the old debt.

    The old debts are sold and re-sold to debt scavengers who re-age the accounts, keeping them on my credit report. Then a second creditor, right before debt was to lapse (SOL), sued and won a judgment and got me into an unsustainable repayment agreement ($250/mo on a part-time minimum wage income). That stressed me out to the point I lost my job and obviously with income gone so were my payments. This in turn led to a rent delinquency and I moved to a cheaper place which I found on craigslist (I know better than to even try to go through a credit screening)’

    I’m pretty much staying below the credit radar, as I’m not applying for anything and have no open accounts, and no new activity other than the second judgment.

    And there’s a 25-year-old tax lien in there from a time when I worked for a startup that didn’t have its accounting properly set up and paid employees as contractors, without bothering to file 1099s either. (Employee work was generally billed to employer’s clients and my employer didn’t feel responsible for the added issues of treating us as either w-2 employees or 1099 contractors – hey, the money came from the clients, he was just a pass-through, so the clients should file the paperwork.. (Weird, I know, but he didn’t get audited, so as far as he was concerned it worked.)

    Dummy me filed a tax return accurately reporting my income, while underpaying my estimated taxes as I was earning slightly above minimum wage and was juggling student loan payments and rising rents. Unable to pay the taxes I owed, I got slapped with a tax lien which is still on my credit report.

    Currently I am living on a poverty level income and see no way to either resolve the debts or improve my credit report or score. I’ve applied for no new credit in the past ten years but the old issues keep getting re-aged or simply (e.g. tax lien) do not get removed. After my previous unsustainable payment arrangement, I stay at least one address ahead of my creditors. (I’m currently two addresses ahead of my creditors and my credit report, the house I moved into was foreclosed and I had to find a new room to rent.)

    I don’t see a way out of this hole at least not on a poverty level income.

  3. James 08/18/2012 at 7:35 pm #

    Good stuff, I think a lot of people aren’t aware of how important FICO scores are. That said, its not 100 percent clear to me that if people have bad credit they are reliable in other aspects of their life. For example, they may have a poor credit score or have filed for bankruptcy because of poor health conditions – like getting cancer or a business failure…factors that are a bit out of control of the individual.

    That said, you make a good point.

    • Paul 08/19/2012 at 1:37 am #

      There are many factors beyond your control that can affect your credit score, co-signing a loan or sharing an apartment with a roommate that is late on the rent payment. Thanks for stopping by James!

  4. Roger Cruise 05/30/2012 at 7:06 am #

    This is a great, straight-forward explanation of the importance of building and maintaining excellent credit ratings (i.e., FICO scores). Too many people are just interested in short-term fixes like getting their scores up high enough to just qualify for a government-insured mortgage loan (i.e., FHA, VA). The problem with this type of thinking is that it still doesn’t address the issue of paying more for every financeable event when your FICO scores are less than the mid 700’s. We’ve tried to address this issue by compiling the research and experience of cleaning up over 150,000 credit files and putting the strategies and tactics we’ve used into our Credit Power series of eBooks ( There is no more complete source of information on how to professionally clean-up and maximize your credit ratings. If someone is serious about maximizing their credit scores and literally saving thousands of dollars per year in excess interest charges, then you really need to pick up a copy for yourself or someone you care about.

    • Paul 05/30/2012 at 1:05 pm #

      I’ve written several articles on this topic. If people could see the impact of their decisions on their long-term financial health I think more people would change their spending habits.

  5. Shilpan 05/14/2012 at 7:14 pm #

    FICO indeed makes big difference when it comes to saving a great deal on the interest amount for home mortgage or car payment. Better alternate would be to save enough and pay cash. Live way below your means — that’s the formula for wealth building.

    • Paul 05/14/2012 at 8:04 pm #

      It affects the cost of credit for all of us!

  6. Kurt @ Money Counselor 05/04/2012 at 8:42 am #

    I’ve never seen the impact of one’s credit rating on mortgage interest presented in this very effective dollars & cents format. Very compelling. Want to save ~$50,000 over 30 years? Maximize your credit rating before applying for a mortgage!


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