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Your credit score is one of the most important financial numbers you have. With a good credit score, you’ll be able to get better terms and lower interest rates for credit cards and loans.
A lower credit score may lead to higher loan costs or even challenges with qualifying for new credit. If you’ve ever wanted to finance a house, borrow money for an emergency, or take advantage of rewards credit cards, you’ll want to prioritize understanding and managing your credit score.
Continue reading to learn why credit scores are important and how lenders use them.
- Credit scores are three-digit numbers that help lenders determine your creditworthiness.
- The higher your credit score, the more opportunities you have to qualify for loans and credit cards with higher limits and better interest rates.
- Building good credit can take time, but understanding how credit scores work can help you build the habits you need to get that high score.
Why Do Credit Scores Matter?
So what is a credit score and why does it matter? Most consumers over the age of 18 have a credit score which is basically a reflection of your history of managing debt responsibly. Lenders use your credit score to make decisions about how much you can borrow and at what terms.
Credit scores typically range from 300 to 850 and the higher your credit score, the more lenders view you as a responsible borrower. When lenders check your credit and your score is low, they see this as a riskier borrowing situation and may deny your application or offer you a higher interest rate.
Simply put, high credit scores equal more financial opportunities while a poor score can hold you back from accessing credit and even saving money on borrowing costs.
When Do Lenders Check Your Credit Score?
Your credit score affects lending decisions in many different situations. Lenders will initially check your credit when you apply for new credit. Longer processes, such as getting a mortgage, may require a closer and ongoing look at your credit.
Also, lenders can access different versions of your credit score depending on what you’re applying for. For example, auto lenders will look at your auto loan credit score when considering you for financing.
Here’s a look at the role credit scores play depending on the type of account.
The Role of Credit Scores in Getting a Mortgage
Your credit score is one of the most important factors that impact your ability to qualify for a mortgage. Homes cost a lot and lenders want to make sure you have a favorable credit history before loaning you a large amount of money.
Before you shop for a home, you should get prequalified with a lender which can involve a soft credit check or hard credit check. At this stage, lenders want to glance at your credit score and see payment history, how many accounts you have, and if any accounts are in collections.
When you find a home and submit an official mortgage application, the lender and loan underwriter will take an in-depth look at your credit history and review your existing debt. This helps them determine if you can afford to finance a home and if you’ve consistently paid your bills on-time.
Better mortgage rates are available to borrowers with a higher credit score and this can save you thousands of dollars over the life of your loan.
- Credit scoring model lenders commonly use: FICO Score 2, FICO Score 4, FICO Score 5
- Credit score to qualify: 620 and up; also depends on the mortgage loan type
The Role of Credit Scores in Getting Auto Loans
Cars are getting more and more expensive each year and many people need to finance this large purchase. Lenders look at a potential borrower’s credit scores to determine interest rates and other loan terms.
Some borrowers with excellent credit may even get perks such as no down payment, 0% APR for several months, or even 60 days until the first payment is due. Lenders such as banks and credit unions generally offer lower rates than dealerships but you should always shop around for the best auto loan rates before choosing a lender.
Also, taking the time to improve your credit before getting an auto loan is crucial. A good credit score could save you hundreds in monthly auto loan payments.
- Credit scoring model lenders commonly use: FICO Auto Scores, FICO Score 8, and FICO Score 9
- Credit score to qualify: No minimum credit score
The Role of Credit Scores in Getting Personal Loans
A personal loan can come in handy if you are looking for funds to cover a sudden important expense such as home or car repairs, a family emergency, moving costs, or wedding expenses. Personal loans can also be used to consolidate high-interest credit card debt and simplify your debt repayment process.
Lenders will use your credit score to determine if you qualify for a personal loan and what type of interest rate you’ll get. Some lenders cater to borrowers with lower credit scores, but they also tend to charge more fees and higher rates.
Sometimes, it’s easier to get a secured loan with a lower credit score since these loans require you to put something valuable up as collateral.
- Credit scoring model lenders commonly use: Varies depending on the lender
- Credit score to qualify: 610 to 640
The Relationship Between Credit Cards and Credit Scores
Credit cards can be a great tool to help you build your credit, but you generally need a credit score to qualify so it can seem like a catch-22. Some credit card companies may run a soft credit check on your to prequalify you for a certain credit card.
Soft credit checks don’t impact your credit score, but if you apply for a credit card, this will result in a hard credit pull which can show up on your credit report as a hard inquiry.
Credit card companies reserve the best credit card options for borrowers with a great score over 740. These cards usually offer lower interest rates, low fees, and rewards like cash back and bonus points per dollar spent.
If your credit score is lower, you may still qualify for a credit card but may not get favorable terms. Credit cards for lower credit scores typically have fewer perks, monthly maintenance fees, and higher interest rates.
Some credit card issuers also offer secured credit cards geared toward people looking to rebuild their credit history. Secured cards require an upfront deposit of $200 to $300 which serves as your credit limit to borrow against. With secured and unsecured credit cards, it’s important to make sure your payments are being reported to the three major credit bureaus (Experian, Equifax, and TransUnion) to impact your credit score.
- Credit scoring model credit card companies commonly use: Varies depending on the credit card
- Credit score to qualify: Fair credit or better
Who Else Might Check Your Credit Score?
Your credit score doesn’t just help you secure loans and become eligible for credit cards. In addition to lenders, other organizations and companies may consider your credit score as well.
In most U.S. states, insurance companies are able to factor in your credit score when determining your insurance rate. FICO, one of the most popular credit scoring models, comprises credit-based insurance scores that insurers can use to determine how well you manage your finances and your likelihood of filing an insurance claim.
Improving your credit score could help you save some money on car insurance premiums and home insurance rates since about 95% of auto insurers and 85% of homeowners insurers use credit-based insurance scores.
Some utility companies also check your credit score to see if you’ve had any issues paying bills in the past. Companies may also base their decision to approve you for a new service based on your credit score.
If you have past-due utility accounts in collections, this may be a red flag to the utility company you’re looking to use. Sometimes, these companies will approve you even if your credit score isn’t great, but they will charge a deposit that can be paid over the course of one to three months.
The deposit is charged in addition to your monthly usage bill.
Landlords can use credit checks to help them make decisions about who to rent a property to. If you fail to pay your rent at a previous residence, this could come back to bite you when you try to apply for a new lease in the future.
Some landlords are stricter than others when it comes to credit and background checks and may deny your application if it doesn’t meet their minimum credit score requirements. There may be an option to apply for a lease with a co-signer who has better credit if you have a friend or family member co-sign for your rental.
Employers may run a credit check on potential employees as well. They won’t actually see your credit score, but they can see your payment history and how well you manage debt and bills.
Depending on the nature of the job you’re applying for, your credit score may not play a significant role. It’s just one piece that is factoring into hiring decisions along with your interviews, references, experience, and more.
How Is Your Credit Score Calculated?
Several factors impact how your credit score is calculated and this information is usually displayed on your credit report. The three main credit bureaus use the information from credit reports to generate credit scores.
Your credit report shows a detailed history of your accounts, payment history, credit inquiries, and total debt amount so you can see how this information helps generate your score. Here are the exact factors that make up your credit score and why they are included.
- Personal information. This includes your legal name, current and past addresses as well as current and past employers.
- Credit accounts. Any personal loans, student loans, auto loans, credit cards, and other types of credit accounts you have open.
- Credit inquiries. Only hard credit inquiries will impact your credit score.
- Bankruptcies. Bankruptcies are public records and can stay on your credit report for up to 7 to 10 years.
- Accounts in collections. These are past-due bills where the creditor has reported the account to a collections agency. Even if you have debt in collections, you should still try to pay these balances off.
Each person has many credit scores because there are several different credit scoring models and variations within each model.
FICO is the most well-known and frequently used credit scoring model. FICO scores are calculated using the following information:
- Payment history: 35%
- Amounts owed: 30%
- Length of credit history: 15%
- Credit mix: 10%
- New credit: 10%
What Is a Good Credit Score?
FICO credit scores are grouped into different categories, ranging from poor to exceptional. Here are more details on what these credit score ranges mean.
What are the credit score ranges for FICO scores?
- 300 to 579: Poor - Poor credit means you have a very low credit score and may not qualify for a loan
- 580 to 669: Fair - Fair credit is better than poor, but it’s still a risk and you should expect to pay higher interest rates and fees if you’re approved for a loan.
- 670 to 739: Good - With good credit, you should have lots of loan and credit card options with reasonable terms.
- 740 to 799: Very good - Very good credit means you have a strong record of responsible financial behavior and you should expect to get approved for most loan options and receive favorable terms.
- 800 to 850: Exceptional - Exceptional is at or near perfect credit and you can expect the same benefits as someone with very good credit.
How Can You Boost Your Credit Score?
No matter where your credit score currently stands, there are many ways to boost your credit score. Here are some specific ways to improve your credit and maintain a good credit score.
- Always make on-time payments. Payment history is the biggest factor that impacts your credit score so make sure you’re paying debts and credit card bills on time. You may even want to set up automatic payments each month so you never miss a minimum payment.
- Manage your credit utilization. Avoid utilizing your entire credit limit with revolving loans and credit cards. Instead, try to keep your total utilization well below 30% of your overall credit limit.
- Limit credit applications. Too many hard inquiries can negatively impact your credit. Limit new credit applications and allow up to two years for most hard credit inquiries to fall off your credit report.
- Become an authorized user. If you have a friend or family member with good credit, ask if you can become an authorized user for one of their credit cards. You’ll get your own card under their account and can practice healthy financial habits to build credit.
- Apply for a secured credit card. Credit cards can help you rebuild your credit when you keep spending low and make on-time payments.
- Apply for a credit builder loan. Credit builder loans allow you to borrow a small amount of money and your monthly payments get reported to the three major credit bureaus to boost your credit.
Your credit score is a clear indicator of financial health and there are true benefits of having a good credit score. Credit scores play a very important role in your ability to get a loan or credit card whether you’re looking to finance a car, earn credit card rewards, or buy a home.
The better your credit score, the more favorable loan terms you can expect including lower interest rates. Even if your credit score is on the lower side right now, you can work to build strong credit over time by practicing healthy financial habits such as keeping debt balances low, limiting hard credit inquiries, and paying bills on-time.