Key takeaways

  • In general, the higher the credit score, the lower the interest rate a borrower can get.
  • A credit score gives lenders a quick, simple way to judge a loan applicant’s creditworthiness.
  • The biggest factor in a consumer’s credit score is always making debt payments on time.

Did you know that a 3-digit number could have a major impact on your financial future? You should. The number is your credit score, and we’re here to talk about how your credit score impacts your interest rates. In fact, because of that impact you might find that your credit score affects many big financial decisions.

The most commonly used score is called a FICO® score. Credit bureaus compile information on consumers’ credit activities. FICO® is the dominant company in analyzing that information—the consumers’ credit reports—and issuing credit scores. The score gives a snapshot of your credit history to lenders.

With the right knowledge, you can build good credit so that borrowing money will cost less in the long run. In this article, we’ll look at how credit score impacts interest rates.

Access your free credit report at Best Egg Financial Health. We may help you better understand your credit report, get tips on how to achieve a higher credit score, and even simulate how your credit report will be impacted by different situations, like paying off debt or opening accounts.  

How Lenders Use Credit Scores

Your credit score essentially gives lenders an idea of your credit risk. They need to know the likelihood that you’ll meet payment requirements and make your monthly payment on time. Banks, credit card companies, and other financial institutions use your estimated risk level to determine if you’re a good candidate for a loan or a line of credit.

Credit scores typically range from 300 to 850. The higher your score, the more likely lenders are to believe that you’ll be able to repay your debts on time. Because lenders consider people with higher credit scores to be lower-risk customers, they’re more likely to offer incentives like lower interest rates or higher loan amounts. The opposite goes for those with lower credit scores. They tend to get approved for loans and credit accounts at higher interest rates.

A score of 700 or higher is generally considered to be a good credit score, and it’s a great target to aim for if you’re building or rebuilding your credit.

Interest Rate on the Loan

When you’re checking out credit accounts or loans, you’ll notice that most lenders disclose a potential range of interest rates. Once you apply and the lender sees your credit score, it will base the interest rate on your creditworthiness. An excellent credit score could translate into a lower interest rate, meaning you’ll spend less money to borrow money. That’s especially important if you’re making interest payments on a long-term loan.

To illustrate our point, let’s take a look at how much money a high credit score can save you on a 30-year fixed-rate mortgage loan by helping you secure a lower mortgage rate.

You’ll notice that the APR (or interest charged on a yearly basis) varies by only about 1.5%, yet the savings over a 30-year period are immense. Paying $70,000 less for a home for having a good credit score? Count us in!

Now, let’s say you have poor credit and you’re looking to buy a home. It’s likely that any mortgage rates offered to you will be on the higher end of the spectrum. Not only will you spend more money over the life of the loan due to those higher interest rates, but it may impact how much house you can afford. You might have to settle for a smaller house or buy in a neighborhood that’s less than ideal. It can also cut into how much of a down payment you can afford, meaning you might end up having to pay private mortgage insurance on top of your mortgage.

To sum it all up, the better your credit score, the better your chances to get the best interest rate.

The same goes for an auto loan. Higher interest rates could keep you from buying that car you really want or the trim level you desire.

Whether or not You Get Approved for a Loan or Credit Card

Your credit score isn’t the only thing lenders look at, but it’s an important piece of the puzzle. Many lenders have standards on minimum credit scores, although they don’t necessarily reveal them.

Your score can also determine whether you qualify for credit cards that offer rewards on specific purchase types. Your score could keep you from getting a card that offers the rewards or credit limit you’re hoping for.

Term (amount of time for the loan)

Your credit score could affect the term (amount of time for the loan), too. The shorter the loan term, the lower the risk to the lender. You may be offered a shorter-term loan if your score is too low. That will mean higher monthly payments based on a more compact repayment schedule.  

How to Get Your Credit Score

There are many ways to get your credit score, including at Best Egg Financial Health. Many credit card companies and loan providers give customers their scores on a monthly basis. Other services provide scores, but some require that you sign up for a monthly subscription. And you can always pay for your credit score from providers like myfico.com.

Credit histories also are available from some of these sources, too. However, you can receive one free credit report each year from annualcreditreport.com, thanks to the Consumer Financial Protection Bureau.  

What Factors Influence My Credit Score?

A credit score is a snapshot of your financial standing. It reflects information like how many credit card accounts, installment loans, or auto loans you have. It also includes your credit utilization, credit mix, and outstanding debt.  (NOTE: Use Same graphic from existing URL)

These five combined factors determine your credit score, and they have varying amounts of influence on it. Here’s why:

  • Payment history. This has the biggest impact on your credit score. Lenders like seeing that you have paid back past debts in a timely fashion before they loan you money. If your payment history shows lots of missed or late payments, this can seriously impact your ability to secure a new personal loan or credit account.
  • Outstanding debt. If you already owe a bunch of money to other lenders, you’re less appealing to new lenders. They might worry that you can’t keep up with all that debt and pay them back on time. This factor considers how much of a consumer’s available credit has been borrowed, which is known as credit utilization.
  • Length of credit history, credit mix, and new credit inquiries. Though they play a much smaller role, you shouldn’t ignore these factors. Think about it this way: If you were considering loaning a friend money, you’d want to know how long they have been managing debt responsibly, whether they have experience with different types of debt, and whether they have borrowed from other sources lately.

Minimum FICO® Credit Score Generally Required for Different Types of Loans

FHA Loan:

  • Ideal for people who have lower credit scores or little cash for a down payment.
  • Approximate credit score required: 580

Conventional Loan:

  • A popular mortgage loan option for people with good credit.
  • Minimum credit score required: 620

VA Loan:

  • A mortgage program offered to veterans and active service members, with zero down payment.
  • Approximate credit score required: 620

Unsecured Personal Loan:

  • A type of installment loan that requires no collateral and can be used for a variety of purposes, from debt consolidation and home improvement all the way to medical expenses.
  • Approximate credit score required: 620–660+

USDA Loan:

  • Offered to low-income borrowers who are looking to buy a home in a designated rural area.
  • Approximate credit score required: 640

Home Equity Line of Credit:

  • A loan that allows you to borrow against the equity in your home and use the funds for home improvement, debt consolidation, or other major expenses.
  • Approximate credit score required: 680

Jumbo Loan:

  • Designed for people who wish to purchase a home that costs more than traditional loan limits.
  • Approximate credit score required: 700

If your credit score is below 580, unfortunately, you could have a tough time qualifying for most credit cards and loans. While you’ll have to put in some work, building or rebuilding your credit is possible, and our article 6 Tips for Building Your Credit is just the place to start.

Published

June 18, 2019

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