Your credit score determines your borrowing power and in many cases can be the difference between a simply good, and a great, interest rate.
Your credit score is much more than a numerical expression of your creditworthiness. It’s the difference between getting the best interest rates on a new car, home or credit card — and getting the worst. A good credit score empowers you to shop with the best companies and pay less overall for your purchases.
How is my credit score determined?
A VantageScore and a FICO Score — the two most widely used scores — both weigh the same factors when determining your credit score, including:
- The age of credit history — or how long you’ve had credit.
- How many credit applications you’ve recently submitted.
- Your payment history, including late and on-time payments, collection actions and judgments against you.
- Your credit utilization ratio, which is calculated by dividing your balance on existing credit cards by your available credit limits.
- How many installment loans, auto loans, credit cards, mortgages and other types of credit you have.
What is the range of credit scores?
Need a new car?
Consumers more often feel the force of their credit score when buying a vehicle. Let’s say you want to buy a new car but your credit score is only 580. This score is considered “poor,” and without a cosigner it will be difficult to get that gorgeous auto you’ve been eyeing. Lenders consider a score of 580 as high risk or subprime.
Subprime refers to loans offered to borrowers with poor credit who do not qualify for prime rate loans. Subprime rates are higher and cost the borrower more.
There are many auto dealers who work specifically with this group of “high-risk” consumers, and they will sell you a car. The problem comes with the selection available — if you only qualify for a car loan of $9,000, you won’t be able to purchase that brand-new BMW — and the interest you’ll pay.
In many cases, you’ll have to settle for a less desirable vehicle, and you will pay much more than what most people are paying in interest — sometimes interest as high as 18%. In addition, you may be asked to put more money down on the car. The dealership wants to collect as much in cash as possible at the beginning of your financial relationship with them in case you default on your loan.
Imagine that you find a great older car that runs well for $8,600, but the car salesman tells you that your credit score is 580 and you’ll have to pay 15% in interest on your purchase.
580 credit score: Monthly payment on $7,600 loan at 15% interest
|Loan term||48 months|
After four years at 15% interest, you will have paid $10,153 for your $7,600 loan (or $8,600 less your $1,000 down payment). That’s $2,553 in interest over the life of the loan.
With an improved credit score, you’re eligible for a lower interest rate. For example, here’s the same transaction with an “excellent” credit score of 720.
720 credit score: Monthly payment on $7,600 loan at 3.29% interest
|Loan term||48 months|
Here, after four years at 3.29% interest, you will have paid $8,121 for your $7,600 loan — or $521 in interest over the life of the loan.
With poor credit, you’ll pay $43 more per month for the same car — more than $2,000 in interest over four years. This is simply the cost of having a lower credit score. When you apply those same interest rates to a $300,000 house, you’ll be stunned at the differences in what you must pay.
Is there a ‘best’ credit score?
In short, no. The three major reporting agencies — Equifax, Experian and TransUnion — vary in how they rate the quality of a credit score. But scores run between 300 and 850, with 680 to 719 generally considered a “good” rating. A score in that range will usually get you the best interest rates on credit cards, mortgages, personal loans and auto loans.
The average credit score in the U.S. is currently between 600 and 750.
Credit score ranges and ratings according to finder.com
How can my credit score differ between lenders?
Lenders and even the bureaus use many different proprietary algorithms to weigh the information in your credit history, but two scores are most widely adopted.
FICO Score. This score is often used by lenders. Anything above 670 is a “good” score, and 800 and above is “exceptional.”
VantageScore. This score is also used by the three main credit bureaus. Its scoring method is similar to that of FICO in that scores range between 300 and 850. If you have a VantageScore of 700, then your credit is “good,” but 750 is “excellent.”
How do I get my credit score?
Better treatment in the showroom
Paying more for every financed purchase comes with another subtle but important factor. Walking into a car dealership with a 725 credit rating will get you the royal treatment. On the other hand, walk into that same dealership with a credit score of 540, and you may be treated differently. The dealer might tell you they are be able to sell you a car, but with your credit, they’ll charge 14% interest instead of 4%.
Though it’s unfair, people with good credit typically are dealt with differently when making a big purchase. This includes homes, cars, furniture and appliances. Life can seem better if you have good credit. So what can you do to improve your credit rating?
How to begin repairing your credit
Many companies today claim to be able to improve your credit score. However, these claims are often not legitimate.
Unfortunately, there’s no quick fix when it comes to repairing your credit. It can take months or even years to rebuild bad credit. So don’t put it off any longer. To get started:
- Pay down your credit card accounts. Your overall credit score is determined by many variables, including your credit utilization rate. Only carry a balance with a utilization of 30% or less. For example, if your credit limit is $1,000, keep your balance below $300, which is 30% of your limit.
- Avoid hastily closing unused accounts. While this seems like a good strategy in theory, having only newer accounts will result in a lower score. Lenders want to see a history of credit.
- Don’t open new accounts until your score improves. By waiting, you can take advantage of better interest rates.
Though credit agencies allow you to file a formal protest if you feel a past creditor has treated you unfairly, the process takes time and patience. If you can provide documentation to support your claim, you may be able to get a bad “ding” on your credit report removed.
Compare providers to get your credit score
Why do credit scores matter?
Credit scores are important because a higher score generally indicates that you can wisely manage your finances. For instance, if your FICO Score is between 670 and 739, a lender will see you as less likely to become delinquent on your payments. Their research has confirmed that within this group, only 8% of consumers will become delinquent in the future. That makes you a “good” credit risk. So you are more likely to get approved for a loan or credit, and you’ll pay less because of a better interest rate.
What’s the bottom line?
When it comes to credit, tread carefully. If you’re in college or even high school, don’t make frivolous purchases on the spur of the moment. It can take 3 to 10 years for a negative item to fall off of your credit report. Shop around, get advice from a trusted friend and sleep on it before making a big purchase like a motorcycle or car. It’s often a good idea to sit down before shopping and write out your expenses and income. Then you can decide on a payment that comfortably fits into your budget.
Remember: Into every life a little rain must fall. Take into account life events that could affect your ability to pay your bills on time. You could lose your job. A sickness or injury could mean taking off several weeks from work. And divorce often adversely affects your finances. Through each of these difficulties, you have options to maintain your credit score if you are prepared.