As long as the question has been asked, let’s talk about credit scores for a minute. I say, “What’s the big deal?” We are taught to revere our credit scores. Hurting a credit score is the unstated, endgame of many financial decisions when the decision maker doesn’t even realize it. For instance, someone says, “I can’t afford that house.” What does that really mean? It means if he or she buys the house and finds, down the road, they there isn’t enough income to comfortably cover the mortgage, that they may have to sell at a loss, OR WORSE, take a short sale or a foreclosure… and here’s the unstated endgame: which will hurt my credit score.
But so what? What is a credit score? It is a vague, logarithmic calculation that assesses risk for lenders. A low credit score, which would mean the borrower is high risk, doesn’t mean the lender won’t lend to them, only that the loan will come with more points and higher interest so that the lender can make more profit sooner in case the borrower defaults. Yes, in the current financial crisis, a lower credit score may make it harder to get a loan, but there are people with high credit scores who can’t get loans right now.
Let’s do the math on what a low credit score might cost. Say you are buying a $25,000 car, $5,000 down and $20,000 financed. If you have a “good” credit score, you might get a 5% loan. Over 60 months, the total interest paid will be $2645. With a median credit score you might get a 6% loan which would amount to $3199. A bad score with a 7% loan, $3761. The difference between the high score and the low score is $1100 in interest over 60 months, about $18 a month.
What about with a house. Say you want to buy a $500,000 home with 20% down (sorry, the 0-10% down days are over for awhile). So you’re financing $400,000 for 30 years. At 5% you’ll pay $373,000 in interest. (I know, brutal, right? Most people when they buy a home never really consider what that home will actually cost buy the time they are done paying it off, but that’s another blog). A 7% interest, you’ll pay $558,000 in interest. A difference of $513 a month for 360 months. And that’s not considering the very likely possibility that over time interest rates in general will come down and you’ll be able to refinance anyway.
The point is, IT’S NOT THAT BIG OF A DIFFERENCE. $18 a month on a $25,000 car. $513 a month on a $500,000 home. Yeah, sure, is $500 a month and that’s not meaningless, but it’s not the “oh my gosh I might hurt my credit score what am I going to do?” doomsday heart palpitations that so many people have when they even consider the notion of their credit score being under 700, or under 600.
When I had an 800 credit score I was able to get over $200,000 in credit to pursue a business venture. When the business venture didn’t work out as planned and I couldn’t meet my monthly interest payments on my cards, I began to negotiate settlements. In about six months I reduced by credit card debt from $212,000 to $30,000 and I had $115,000 in debt written off.
$115,000! I can’t buy enough new cars in my lifetime at 2 or 3% higher because my credit score fell 150-200 points to save enough in interest that it would add up to more than I saved by settling my debt. Had I been the homebuyer in the example above, I would have paid $185,000 more in interest over 30 years, compared to saving $115,000 in six months.
I’m not suggesting that anyone abandon their credit score to the wind and adopt unsound financial habits. I am suggesting that in the conversations you have with your attorney, accountant, spouse and self, give credit score considerations their proper due. They are a single part of a large financial equation, not the end all absolute factor that your lenders would have you believe they are.
If you find that you have to miss a mortgage payment or two because you’re between jobs or had unexpected medical expenses or your son or daughter in college has a once-in-a-lifetime chance to meet President Obama but has to fly first class and stay at the Hay-Adams, then factor a drop in your credit score into a financial equation about when you might need to borrow money again and how much an extra percentage point will cost you. Don’t tell your kid to stay in the dorms that weekend to save $18 a month on a new car.
I have a good written offer to settle with one card company. Can I settle with one and wait until I can get enough money to settle with another? Do I have to make token payments on the other cards until I can settle? Do I write to the other companies telling them what I am trying to do?
Hi Christy,
From what I experienced, each bank and each card is treated separately. I settled with my first bank in August of 2008, another in October, November and December. I continued negotiating with those that I hadn’t yet settled with even after settling with others. If you do not have any funds available to settle with all of your creditors at once, there is nothing that prevents you from settling with those you can when you can, and then putting more money aside to settle with others later. As for writing to banks to tell them what you are doing, they’ll know anyway. Settlements are reported and any bank that has a loan out to you can pull that information at any time. In my experience, it seemed that settlements with the later banks were a bit speedier when they started to see I was settling with other. I hope that helps. If you haven’t yet, I really hope you pick up a copy of “The Do-It-Yourself Bailout” to see how all of these things work out in real experience. All the best, Kenny Golde