The high cost of low credit scores

 

Record-low interest rates are useless to the millions of borrowers with less-than-stellar credit scores. They end up paying a high premium when applying for everything from credit cards to home mortgages.

Despite the Federal Reserve's efforts to encourage more lending and home buying, millions of people have been shut out from borrowing, according to a report by The Wall Street Journal. Consumers with high credit scores accounted for nearly 90% of all new mortgages last year.

 

This comes at a time when the number of Americans with poor credit is growing. Most lenders check borrowers' FICO credit score, which ranges from 300 to 850, to determine whether to approve them for financing and at what terms. In general, borrowers with a FICO below 720 will end up with higher interest rates and could have a harder time getting a loan.

 

Today, nearly a third of consumers have a FICO score in the 550 to 699 range -- the highest since 2006, according to April data from FICO. And nearly half of consumers have a FICO score that's lower than 700.

 

Lenders say the premium for poor credit is necessary to manage their exposure to risk, with requirements varying widely by the type of loan. For those with poor scores, credit cards and car loans are the easiest to access, but the premiums may be very high.

 

Credit card issuers charge at least 17% interest rates on average for borrowers with credit scores below 720, according to Card Hub, a credit-card comparison website. On car loans, average interest rates run up to 13% for borrowers with lackluster credit scores, according to credit bureau Experian.

 

Mortgages remain hardest to get: Few lenders are giving mortgages to borrowers with scores below 680, says John Ulzheimer, the president of consumer education at SmartCredit.com, a credit-monitoring site. While lending standards have eased since 2008, the best rates -- or even the good ones -- are available only to those with perfect or near-perfect scores, says Ulzheimer. (Post continues below.)

Here are the three major loans affected by poor credit:

 

Car loans

Borrowers with shaky credit can qualify for a car loan, but they'll pay a steep price. Roughly 44% of car loans originated during the first quarter of 2012 were given to subprime consumers, meaning those with scores lower than 680 (based on the so-called PLUS range of 330 to 830), according to the latest report by Experian. That's up nearly 6% from a year prior.

 

Interest rates on car loans vary significantly based on the borrower's score. The best borrowers who have at least a 740 score pay 3.2% interest on average on new car loans, and borrowers with 680 to 739 scores pay 4.5%, according to Experian. Borrowers with lower scores could pay anywhere from 6.5% to 12.9% on average.

 

The difference adds up: On a $10,000 five-year (the average term) new car loan at a 3.2% rate, monthly payments will be about $181 -- with some $860 in interest paid over the life of the loan. At 12.9%, payments are around $227 per month, or $3,620 in interest over five years -- an extra $2,760 compared to the borrower with pristine credit.

 

Credit cards

Over the past year, qualifying for a credit card has become easier for borrowers who don't have pristine credit. But the rates they'll get will be more than seven percentage points higher than borrowers with near-perfect scores.

 

Consumers with credit scores above 720 (based on the FICO score that ranges from 300 to 850) were charged 12.9% interest rates on average during the first quarter 2012, according to the latest study by Card Hub,  a credit card comparison website. Borrowers with FICO scores from 660 through 719 paid 17.1% on average and borrowers with scores from 620 through 659 paid 20.3% on average.

 

Borrowers with even lower scores who want a credit card might consider a secured card, says Odysseas Papadimitriou, the chief executive at Card Hub. To get a secured card, a borrower gives the credit card issuer what is essentially a security deposit, usually at least $200, which establishes a line of credit. Their interest rates average 17.7%; in comparison, the few regular credit cards that exist for this group of borrowers charge 30% to 36% interest.

 

For credit card users, interest rates kick in if they carry a balance. In that case, card users with the highest credit scores will save. With a 12.9% rate, borrowers who have a $5,000 balance on a credit card and send $150 per month toward paying it down will pay about $1,235 in interest. With a 20.3% rate, they'll pay $2,421 in interest.

 

Mortgages

Out of all consumer loans, mortgages remain the hardest to get, especially for borrowers with poor credit. Borrowers with scores below 620 are unlikely to qualify, says SmartCredit's Ulzheimer.

 

Lenders say borrowers' FICO scores are the most important factor in determining whether they'll get approved for a loan and what their rate will be, although their overall debt compared to income and their down payment size play a role as well.

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Borrowers who have FICO scores of at least 760, make a 20% down payment, have a $300,000, 30-year mortgage, and pay one point up front (that equals one percentage of the mortgage amount) will have average annual percentage rate of 3.3% for about a $1,311 monthly payment, according to Informa Research Services.

 

On the other end of the spectrum, those with 620 to 639 scores -- if they can get approved -- will pay 4.9% on average or $1,587 per month -- and annually will pay $3,312 extra per year.

 

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