Late payments are best avoided if at all possible. They play havoc with your budgeting, and could also incur financial penalties. If you’re likely to forget to make payments on time, it may be best to set up automatic payments such as direct debits or standing orders, to ensure that regular payments are made as they become due.
Many people don’t realise that late payments can also affect individual credit scores. The credit score is universally known as the FICO score, from the Fair Isaac company who developed the scoring model and licenced the software to the credit bureaus who compile credit reports. It’s used by financial institutions to assess credit risks. FICO scores range from 350 to 850, with a score of less than 620 being considered high risk, or sub-prime.
Late payments could have serious consequences if you want to apply for a personal loan, a mortgage, or even car insurance. Here’s how late payments could impact on your credit score.
Payment history is important in credit scoring
Several factors are used to calculate individual credit scores, but payment history accounts for 35% of the total. Payment history includes late payments, bankruptcy, and defaults on debts. Late payments will lower your credit score.
Recent late payments have a more detrimental effect than older defaults, but all late payments can remain on your credit report for up to seven years. The length of time taken to bring payments back in line also affects the credit score, and the longer a payment is outstanding, the more detrimental the effect on the credit score.
If several accounts show late payments which took 120 days or more to resolve, this will have more impact on the credit score than the same number of accounts where payment was 30 days overdue.
Increased interest rates
If late payments take your credit score into the ‘high risk’ area, you could be refused credit of any description. Even if a loan is advanced, you may find yourself paying more in interest charges than someone with a high-end credit score. Lenders justify these higher rates because someone with a low credit score is more likely to default on the loan.
On a 30 year fixed mortgage of $150,000, someone with a credit score of 760 – 850 would repay $856 monthly, assuming an interest rate of 5.55%. However, a consumer with a credit score of 620 – 639 would repay $1,012 on the higher interest rate of 7.15%.*
That may not look too bad on the surface, but that extra $156 each month adds up to $56,160 in extra payments over the lifetime of the mortgage. That’s an unacceptably high price to pay for a late payment or two.
Higher insurance rates
Statistically, drivers with low credit scores file 40% more claims than their more creditworthy cousins.* Insurance companies use this to underwrite new business, and you could end up paying 20 – 50% more for your car insurance.
While late payments alone do not impact on your credit score, a recent late payment is likely to influence your credit record in ways disproportionate to the default sum involved. To ensure that you get the best possible deals on financial products, be sure to make all repayments on time. You know it makes sense.
Sources:
http://www.myfico.com/CreditEducation/WhatsInYourScore.aspx
*http://www.privacyrights.org/fs/fs6c-CreditScores.htm
*http://moneycentral.msn.com/content/banking/yourcreditrating/p56621.asp