Why Bad Credit Equals Higher Interest

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It’s an unfair system – having bad credit (or no credit) means you’ll pay higher interest rates on loans. It’s like the banks and lenders want to punish people for having made some mistakes or poor financial decisions.

It’s not fair…but it does make sense, and there are legitimate reasons for it. Before you  dive into our quick guide for rebuilding your credit, take a minute to understand why it’s so important to have that good credit, and the two real reasons why lenders are more inclined to raise the rates for low (or no) credit individuals.

  1. Risk
  2. Assumed Additional Costs

As we talked about in our article on what’s behind a credit score, your credit score is like a report card that tells lenders how likely you are to pay back money that you borrow, and how much of it you’ll pay back.

The bad news is that it’s just a number – it doesn’t take into account the circumstances or situations surrounding the loans, only whether or not you paid it back, and paid it back in full.

The good news is that it’s just a number – it doesn’t take into account the circumstances or situations surrounding the loans, only whether or not you paid it back, and paid it back in full.

(this is why we recommend taking out very small loans and paying them back immediately to quickly rebuild your credit score)

When a lender looks at your credit and sees a low score, they get the impression that you don’t pay back your loans, or you don’t pay them back on time, or that you don’t pay them back in full. In short, they think that they’re not going to get their money back.

Nobody wants to lend money to someone they think will never pay them back, so they have to make it worth taking that risk by charging you more. They’re taking on the real risk by lending money, so they want to know that their risk paid off as big as possible, hence the higher rates. If you prove yourself to be a safe bet, they’ll give you higher loans at lower rates and still make their money back. If not, then not only will they lose the money they extended to you, but they’ll also have to take on…

2. Assumed Additional Costs

It’s one thing to lend someone money and never get it back – that money’s gone no matter what. But big businesses and lenders can’t simply let it go, and they’re going to do anything and everything in their power to get that money back.

This costs money.

Hiring someone to sit in a call center and harass you over the phone? That costs money.

Sending angry letters to your house asking you to pay back the money you borrowed? That costs money.

Hiring a collection agency to track you down and try to collect the debt? That costs money.

When a lender sees a poor (or nonexistent) credit score, they have to assume the worst – and the worst is that not only will they never get their loan paid back, but they’ll also have to then spend money trying to get it back.

Think of it this way:

You want to borrow $100, but you have a poor credit score so the lender doesn’t think you’re going to pay it back. They know that if you refuse to pay it back (or can’t pay it back), they’re going to spend $50 on calls and mailers and collectors to try and get it back, so they set your interest rate at 50% because they’re really risking $150 in lending to you. Once you pay it back and they know that you’re trustworthy, they’re willing to take a larger gamble on you and will drop that interest rate, as will other lenders.

Is it fair? Well, to the lenders it certainly is, but do not lose hope! There are a lot of ways to game the system and raise your credit score and get those lower rates by maximizing your credit score!

Do you have any tips and tricks for beating the system? Sound off in the comments and let us know!

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