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How do you know if you can get a prime loan or if you need bad credit loans instead?
- If your FICO puts you in the “poor” credit category, you will likely need unsecured financing.
- You might even need bad loans if your score is “right”
- Recent events like foreclosures, bankruptcies, write-offs or collections make borrowing difficult
Sometimes increasing your credit score by just one point can take you to the next level and save you thousands of dollars.
Check your new rate (June 30, 2021)
Credit scores for prime loans
There is no commonly accepted definition of the term “prime loan”. Each lender is free to set its own standards for loans it qualifies as “premium”.
But the term generally means a loan that offers the best possible deal to a consumer. It usually comes with low interest rates and sometimes other privileges.
There is one exception to this description of “best possible offer”. Some lenders may offer very high yield loans and then the best possible deals are given to those borrowers. But any prime loan is, by definition, attractive.
What scores qualify for blue chip loans?
FICO is the company behind the most widely used credit scoring technologies. It categorizes credit scores as follows:
- 800+ – “Exceptional”. Surprisingly, 20 percent of Americans have a score of 800 or higher. And 1% have one in 850, which is the highest it can get. Only 1% of those with a score of 800+ are likely to default on a loan, so lenders love these borrowers and can afford to give them great deals.
- 740-799 – “Very good.” You are still well above average and there is only a 2% chance that you will default. So lenders still love you, and almost all of them are likely to see you as a prime loan candidate. Twenty-three percent of consumers belong to this group.
- 670-739 – “Good.” There is an 8% chance that your loan is in default, which means that only certain lenders are likely to consider you eligible for a prime loan. Twenty-four percent of the population belongs to this group.
It should be noted that most of us have dozens of different credit scores. This is because there are different rating system providers, different credit bureaus, and different versions of industry specific rating systems. So, for example, an auto lender may use a proprietary and modified version that can better predict defaults on auto loans.
On top of that, some lenders have stayed with older “legacy” versions which will score different from more modern systems. This means that you shouldn’t assume that the score you get from a credit score service will be that seen by a potential lender.
Who gets bad loans?
You would think that bad credit loans would only be offered to those with very low credit rating. But some lenders will offer these loans even to those with fair credit scores. With a larger down payment, an applicant with a credit score of less than 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 people in this score range will default on their loans, and they represent 16 percent of the population. Lenders are therefore wary. If you shop around, you might find a nice loan source that will lend you on better terms than a bad credit loan. But there is no guarantee
- 579 and less – “Poor”. Over 60 percent of borrowers in this group default on their loans, and they represent 16 percent of the population. Faced with these risks of default, most lenders will automatically deny requests. Those who agree are required to charge exorbitant interest rates to cover their losses
As FICO says, “The promising news for this group is that there are opportunities to improve their credit rating. “
Do you have a thin file?
Many people have low scores through no fault of their own. Some have had bad luck: a period of unemployment or illness, perhaps.
Others simply have too little information on their credit reports for scoring algorithms to properly calculate their creditworthiness. The industry calls this having a “thin file”.
And this can be a particular problem for young people who haven’t borrowed much yet. It can also affect older people who haven’t borrowed in the past few years. But non-borrowers of any age may be affected.
It might seem like a trap: you can’t borrow without a decent credit score, and you can’t get a decent credit score without borrowing. A secured credit card can be a great place to start in building your credit. You must make a deposit to the card issuer and can then charge for purchases up to your deposit amount.
And you may have to pay interest when you “borrow” your own money. But, by providing your card reports to the big three credit bureaus, your score should increase fairly quickly.
Difference in cost between prime loans and bad loans
The higher your credit score, the less likely you are to pay off all of your loans. This applies to everything: from mortgages to credit cards and 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 end up dropping a hundred thousand dollars over this time period. If you are a big borrower, do it in the hundreds of thousands.
How your score affects your mortgage costs
FICO has a calculator that allows you to calculate the different costs of a new mortgage based on your credit score. The following calculations are based on mortgage rates as of mid-June 2018, but they will likely have changed since.
The Experian credit bureau estimated in January 2018 that the national average mortgage debt was $ 201,811. So let’s say someone borrows $ 200,000 with a 30-year fixed rate mortgage. The calculator indicates that someone with a score of 760-850 could get the following offer:
- A rate of 4.322% APR
- Monthly payments of $ 992
- Total interest paid over 30 years: $ 157,238
For the same loan, someone with a score between 620 and 639 (anyone with a lower score has a very low chance of being approved) might be offered this offer:
- A rate of 5.911% APR
- Monthly payments of $ 1,188
- Total interest paid over 30 years: $ 227,565
In other words, the borrower with the lowest score would throw over $ 70,000 in additional credit charges over the life of their loan.
Auto loans and others
But it’s not just mortgage payments that are affected by a score. FICO says that a person with excellent credit borrowing $ 10,000 in the form of 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 between 500 and 589 $ 4,620 in interest, more than four times as much!
Suppose you have had eight auto loans in your lifetime. You would have lost almost $ 30,000. And, of course, it’s not just mortgages and auto loans. You’ll pay more for every dollar you borrow – and maybe more for your rent and insurance premiums.
Average credit scores in the United States
Average credit scores probably don’t matter much to you. You are mainly interested in your own.
But Time Money published an analysis by age group in April 2017 that lets you know how you are doing compared to your peers:
- 18-29 years: 652
- 30-39 years: 671
- 40-49 years: 685
- 50-59 years: 709
- 60 years and over: 743
The average score of all Americans reached 700 in 2017 for the very first time.
The lowest scores of young people
Why are young people less well? It is probably not because they are fickle.
For starters, they can have thin files. But they also won’t yet have a high median age for their open accounts, which is 15% of a FICO score.
And they may not have such a good “mix” of revolving credit (mainly credit and credit cards) and installment loans, such as mortgages, auto loans, and so on. This mixture represents 10 percent of a FICO score.
Regardless of your age, having a higher score can save you a lot of money. It’s worth taking this stuff seriously. You don’t want to live your whole life burdened with bad loans.
Check your new rate (June 30, 2021)