Credit Score: Ignorance Is Expensive

Did you know that your credit score can decide where you live, what you drive, your insurance, where you work, what you pay for debt and if you get loans? Even if your credit is average, you could still be paying more for loans and debt than you would be with a better score.

How does credit score factor into ...?

• Insurance
• Employment
  
• Housing
• Bank Loans

Insurance

Different rules apply for life, home and auto insurances.

Life insurance

A bad credit score will exclude you from top-tier life insurance, but your score doesn't weigh heavily at any other level, says Scott Menta, a Certified Financial Planner with MetLife Securities in Elmsford, N.Y. Although it does get factored in, it won't affect rates.

"A couple years ago life insurance added a top tier that 5 percent of the population qualifies for, but you are definitely excluded from that if you have a bad credit report. You could literally be an Olympic athlete and would still be excluded based on that score," he says. Forty percent of the population will be in the next tier, above average. Health is far and away the most important factor determining tier; 50 percent will be in the average tier.

Home and auto

Credit scores heavily impact home and auto insurance coverage and rates. With a poor score, you could be denied insurance outright, which is especially tough in cases where the law requires insurance. People with bad credit are assigned to a higher risk group, as insurance companies are finding a correlation between bad credit and a higher number of claims. The logic being that fiscally irresponsible people might turn to insurance as source of revenue, turn to insurance too frequently, pad claims or make dishonest claims, says Menta. "It's a bad risk," he says. "If you have a $500 deductible and a $900 claim, I normally advise my clients to eat it because we don't want their rates to go up. But someone who needs $400 might not only file the claim, but pad it."

What could it cost you? Being in the substandard risk pool costs 30 percent more. "You could have a clean driving record and still be in that group," Menta says.

Employment

Credit reports and credit scores show up in the background checks employers increasingly order at the time of hire or promotion. "It seems like since 2001, the number of companies doing background checks has really jumped," says John Challenger, CEO of Challenger, Gray & Christmas Inc., an outplacement consulting firm that deals with employers across the U.S. and abroad.

"This is in part because of the stock market crash when the country went into recession and the damage it did to people's finances, and in part due to change in the era for security reasons," he says. Another factor behind this growing trend is that the reports have become more and more accessible as prices have come down.

Companies want to find employees that are stable. Between recruiting, placement and development, it's very costly to employ people who leave quickly. Employers will look at both your credit score and credit report to see if you're in a stable place and likely to be a solid employee.

"Employers may check your credit score and credit report to see if you're in a stable place and likely to be a solid employee." The larger the company, the more likely they'll use that as one of their ways of checking backgrounds to understand what issues their potential employees have.

While credit factors in mainly at the time of hire, Challenger says a report could be run at other times before moving someone to a more responsible position or before helping them in some way -- though this is not widespread. Companies ask for a release before pulling these reports so you will know this is coming, and by law your employer must notify you in advance of any negative repercussions based on your credit report information. This is called a pre-adverse action notice. They'll also provide you with a copy of your rights at the same time.

If you have bad credit, Challenger suggests that you be prepared to speak about it, but not to bring the topic up yourself. "You don't want to raise negatives when it might not become an issue. Be prepared to address the issue. Just as if you move from job to job you should be prepared to explain this."

Housing

"We advise our clients, both on rentals and co-op boards, to examine credit reports thoroughly," says Jeff Cronrod, CEO of Fidelity Information Corp., a company that represents 15,000 property management clients nationwide. "We can also provide criminal history, banking history (this is a real-time report that captures a history of bad checks), eviction reports and fraud reports." All of these factors can weigh heavily, though credit is dominant. "Everyone gets the credit report at minimum, although they don't always order the others," he says.

Sixty-five percent to 70 percent of landlords pull the credit score as well. "I don't personally. I don't like them," says Cronrod. Equifax is available on a limited basis to limited clients. Geography generally determines which score landlords purchase, TransUnion dominating the Midwest and Experian the coasts. Rarely do landlords pull both.

Cronrod recommends ordering your credit report at least once a year to protect yourself from innocent or fraudulent errors. "People with common names can get just wrecked; we see it all the time," he says. "There will be confusion for John Smith at a similar address or similar city. There is a lot of confusion between juniors and seniors because have similar address history. These are everyday issues; they occur all the time." Fraud is a significant problem that has increased over the years. An applicant can walk into a rental office with a fake ID and clean credit report, but it's not that person. Cross-checking is necessary.

How much of an impact your credit report or score makes is contingent upon the rental climate in that area. If people are lining up to get in, landlords can be pickier. "Our larger clients are typically more rigid about what to accept because have been given guidelines by corporate. Mom and pop operations tend to get a better picture of you as a person," he says. Talking to the applicant, you get a gut feeling different from the report.

Some credit mistakes factor more than others. "Most of our clients don't count medical and student loans. Some are even lenient about auto loans and credit cards. But most will reject you if they see you don't pay your rent on time." Bankruptcies and foreclosures are big warning signals.

Bank Loans

A credit score is the biggest factor in determining an interest rate, and it's the first thing banks look at. "Any individual should be very conscious of what their credit score is, especially if their credit score is middle to below average," says Karen Casey, an executive vice president at Greater Community Bank, in Montclair, N.J., a CPA and Certified Financial Planner. Some banks use automated underwriting and will reject applicants based on score alone. Other banks might look at why your score has taken a hit. Mortgage lateness or default is a red flag. Most banks will either reject these applicants outright or put them in another category.

Beyond credit score, stability in employment is important. Three years at your current job is best; some banks won't give loans if you've held your job less than a year. Then income and income relative to other expenses factors in. "The rule of thumb is a 40 to 45 percent ratio is considered average. If the total of all debt and rent comes to less than 40 percent, there's a good chance you'll be approved." Food and utilities are excluded from this calculation.

The first thing you should ask a bank is what the criteria is for giving an unsecured loan, if that's what you're shopping for. Secured debt, such as a mortgage or home equity loan, has a better chance of approval. "Be upfront with the bank if you have an issue, bankruptcy, whatever," says Casey. While bankruptcy won't drop from your record for 10 years, sometimes it won't hurt as much after a few years as current nonpayment of debt. "That is the absolute killer," she says. "If you can't pay your loans on time that will really drive your credit down."

Don't apply for loans at several banks, because every time that score is run, it will show up as a negative. If it's a mortgage or auto loan you're after, the FICO scoring system allows you a little more wiggle room. All applications for those loan types that fall within a 45-day period only count as one inquiry. Check out interest rates online at Bankrate.com's rate tables.

"If you see banks that have a lower rate than others, get an understanding of what their process is, then apply if it sounds right for you," Casey says. Talk to someone in their consumer loan or personal loan department.

On the average 30-year mortgage, there's a 3 percent spread, and that's a bigger-ticket item. It can cost you a lot of money to have a poor credit score.

Auto loans

The difference in auto loan rates can be 4 percent to 6 percent, based on your credit score. Some banks will have an even bigger spread. Multiply that by the $20,000 average cost of a car to see how much a better score would save you. Check auto loan rates in your area.

Checkered past?

• Pay your bills, bring everything current, negotiate with collection agencies.
• Look to areas where the rental climate isn't so hot, and try smaller landlords.
• Pull your credit report once a year to check for errors.
• Get a co-signer or put down a larger deposit.