The Truth Behind High Interest

Odds are, if you have bad credit or know some with bad credit, they don’t have much disposable income. So why are these consumers held to crazy high interest rates? Why are they paying hundreds or thousands of dollars more than someone with good credit for the same product. The answer, it’s all about risk.

Your credit score, most commonly used FICO (Fair Issac corporation) Score, is a value used to determine your risk as a consumer, based on the credit worthiness of your credit history. The credit bureaus (Equafax, Transunion, & Experian) track your payment history, how much credit you’re using, how long you’ve had credit, and even the types of credit you have. After calculating all of these factors, the bureaus assign you a score. The higher the number, the less risk a financial institution is taking by offering you a loan.

When a consumer with a higher credit score attempts to acquire a loan from a lender, the financial institutions understand that, because this individual offers a much lower risk, that more likely than not, other lenders would be willing to offer them a loan. In order to stay competitive and look more appealing to you as a customer, the lenders will lower their interest rates to convince you as a borrower to use their loan. On the other hand, if a consumer with a lower credit score applies for the same loan, if they don’t get directly denied for the loan, that consumer face increased interest rates, as they are perceived as a higher risk.

It doesn’t seem fair, but the lenders need to asses their risk as any other business would. Banks and other lenders are in business to make money, and if a consumer with record of late paying or defaulting comes to the table, they need to be sure to prepare themselves for a situation that will require additional cost to recoup the funds, like staff to contact the borrower for late payments or even hiring a collection agency.

Be prepared when you are looking to acquire a loan for a new home, car, or business. Sometimes there is incorrect or inaccurate information on you file that could cost YOU extra money. Get ahead of the game, know what is on your credit report! Keeping track of your credit report ensures that you will not overpay for loans, insurance, and other heartaches that lower scores can bring. Be smart, save money!