Ideally, all decisions we make in life involve consideration of both the pros and cons of possible outcomes. For example, the decision to eat a piece of chicken past its expiration date should be based not only on the possibility of a tasty dinner, but also on the possibility of an unpleasant gastrointestinal reaction.
In other words, most things in life have advantages and disadvantages, and our actions should, but not always, be based on whether the advantages outweigh the disadvantages. While many bad decisions can occur as a result of not considering the drawbacks, just as many bad decisions are the result of not understanding the drawbacks, rather than not considering them at all.
Most people know that irresponsible financial behaviors can get you a bad credit score, for example, but many people tend to underestimate the many downsides of having bad credit. To help you put things in perspective for your next financial decision, here are three of the biggest downsides to having bad credit.
1. You have a high probability of being turned down for new credit
At its heart, having bad credit is basically like walking around with a sign that says, “I can’t take debt.” At least, that’s how most creditors are going to interpret your bad credit history and low credit score when you come to apply for a line of credit.
This is because lenders use your credit reports and scores as a means of determining your credit risk, or how likely you are to repay what you borrow. So if you have a history of late payments or default on debts, lenders won’t want to give you more money and will deny your application for new credit.
Think of it this way: if you lend your neighbor his lawn mower in June but never return it, what are the chances that he will lend you his snow thrower in December?
Since most major banks have fairly low risk tolerances, consumers with bad credit have limited options for finding a credit card or loan. Meaning, you’ll see lists of subprime lenders that specialize in high-risk, bad credit applicants, lenders that aren’t exactly known for their affordability or top-notch rewards. Which brings us to the next big drawback of bad credit: expenses.
2. Creditors, landlords, and utility companies will charge you more
It took a few tries, but you finally found a subprime lender that will work with you. Great, the hard part is over, right? Mistaken. Lest you think that qualifying for new credit is the only big downside to having bad credit, just look at how much that credit will cost you.
As we mentioned, your credit score is what lenders use to determine your credit risk. High-risk applicants are the most likely to default on their debt (not pay it off), so lenders willing to work with consumers with bad credit have to find some way to balance risk. They do this by raising interest rates and adding additional fees.
As an example, consider a car loan of $10,000 repaid over three years. Applicant A, who has an excellent credit score of 750, will likely be offered an APR of about 3.5%, which means Applicant A will pay about $550 in interest over the three years.
At the same time, Applicant B, who has a low credit score of 580, had to use a sub-prime lender to get an auto loan of the same size. The subprime lender charged Applicant B an APR of 10%, which means Applicant B will pay more than $1,600 in interest over three years.
What’s worse, it’s not just lenders and credit card issuers that will charge you more for bad credit. You’ll likely face a credit check when applying for a new apartment or setting up utilities at a new location, and having bad credit can result in being charged a larger security deposit than you otherwise would. would have to provide.
3. You may miss out on valuable financial opportunities
An important part of finance and accounting, opportunity cost is basically the consideration of what you’re missing out on when you make the decision to do something else. For example, if you choose to spend your last $5 on fancy coffee, the opportunity cost might be that $5 burger you won’t eat later.
When it comes to your credit, having bad credit is fraught with opportunity costs. Take credit cards, for example. With bad credit, you’re stuck using subprime or guaranteed credit cards that probably cost a lot without offering much. Conversely, if you had good credit, you could earn hundreds of dollars in credit card rewards and benefits each year simply by using the right credit card.
And it goes beyond credit cards. Drivers with good credit can get dealership incentives when they buy a new car, and you can even get insurance discounts for having a healthy credit profile.
Don’t forget the extra money you’ll probably need to provide when you rent a new apartment. Let’s say you are required to put down a $1,000 security deposit when you move out due to bad credit. That money could easily earn dividends in your retirement account if it weren’t wasted in the owner’s bank account.
Don’t Let Bad Credit Hold You Back
Although it is our own choices that often lead us to bad credit, few of us actively choose to sink our credit scores. You can end up with bad credit as a result of a series of seemingly minor decisions made without regard to the consequences. Hopefully, however, knowing these top three downsides of bad credit will help you gain perspective when making your next financial decision, big or small.
For consumers who already have credit problems, these drawbacks are likely to be daily considerations. But they don’t have to be lifelong obstacles. You can rebuild bad credit over time by practicing responsible credit habits. You can also use credit repair to remove any errors or unsubstantiated accounts that are lowering your score.
The most important rule of thumb for building credit is always, always, always pay your bills on time. Your payment history is worth up to 35% of your credit score, and late payments can cause you to lose dozens of points with a single mistake. You’ll also want to make sure you keep credit card balances low and borrow only what you can afford to pay as agreed.
With time and diligence, even the worst credit can be rebuilt, freeing you from the many disadvantages of bad credit. Even better, having good credit has many advantages that will make the hard work worth it.
