Although the vast majority of adult Americans (and many minors, as well) have some kind of credit to their name or have accrued debt, remarkably few have a strong understanding of how this affects them in their daily lives.
Credit ratings are earned through the accrual of debt and how these debts are paid, be they paid on time, paid late, or if payments go into default. Typically, a person gathers debt in one of three ways: credit cards, automobiles, or homes. Most people build their credit rating (or ruin it) by using a credit card (or cards) that are easily attainable by someone without a credit history. When the individual pays their balance in a timely fashion, a positive rating begins to build. Conversely, when debts are left unpaid one’s rating plummets.
Most ratings range between 500 and 800 points, with 800 being excellent and 500 being poor. The better a person’s credit rating, the lower their interest rate will be. For example, a young person just beginning to build their credit history will tend to have high-interest rates between 12 and 22% APR (Annual Percentage Rate — the actual amount the borrower pays in interest annually). After establishing themselves as a reliable borrower (via on-time payments), the individual will usually find themselves paying rates in the single digits.
When it comes time to make a major purchase, such as a vehicle or house, it is especially important to have achieved a high credit score. Large purchases are usually done with a long-term loan and/or a sizeable down payment. When a buyer has a good credit rating they usually get a low APR as well as being required to put forth a smaller down payment. When a buyer attempts to make a large purchase with poor credit, they not only must put more money down but will usually pay a much higher interest rate and may even have to pay this higher rate over the course of a longer-term loan. For example, whereas a buyer with excellent credit may put down a 2% down payment ($2,000) on a $100,000 house and get a 30 year loan at 6%, a person with poor credit may be subject to putting $5,000 to $10,000 to get a similar interest rate (and may still need to extend the loan by an additional 5 to 10 years). Each additional year amounts to several hundred extra dollars paid in interest alone.
By these simple figures, it’s easy to understand that a good credit rating saves the buyer money in both the short AND long term, therefore paying back debts in a timely manner is the best investment.