Everyone wants a good credit score, but why? Not only is it a great starting point when you’re applying for credit, but it also helps you save money in the long run on things you are going to have to finance.
If your credit score does not reflect responsible credit management practices, auto loans and home loans – known to many as “good” forms of debt – can actually be just as expensive as other liabilities. Therefore, it is important to strive for excellence when it comes to your credit score. Of course a credit score of 750+ is ideal, but even scores in the high 600s can help you acquire lower interest rates which will save you more money long term.
Mortgage Loan Savings
Currently, the best interest rate for mortgages is 3.77%. In order to attain this rate for a mortgage loan you must have a credit score above 760, according to Informa Research Services (a California based firm that tracks interest rates by credit scores). If you have a credit score of 675 it will land you a 4.38% rate which may seem like a small percentage gap, but the difference in money you will be paying out in interest is immense. For example, when you apply a 4.38% rate to a 30 year fixed mortgage of $350,000 the monthly payment is $125 more per month compared to a 3.77% rate mortgage, leading to $45,000 paid in interest over the course of the loan.
Auto Loan Savings
While auto loans are significantly smaller in amount than mortgage loans, having a higher credit score can still save you some serious cash. According to Informa, someone with a credit score of 720 or higher will most likely get approved for an interest rate of 3.2% on a 48 month auto loan for a new car. However, if that same customer had a credit score of 600 they would probably be given a much higher rate of approximately 13.5%. The difference? With the higher interest rate on a $35,000 auto loan, the customer would pay $170 more per month totalling in $9,000 more in interest over the life of the loan. While there is no difference in the car purchased at a 3.2% rate versus at a 13.5% rate, there is a huge different in the amount of money you are paying for it.
Why Low Credit Scores Cost You More
Credit scores are largely based on how financially responsible you are. Someone who has a long history of making payments on time, making payments in full, and has less overall debt is more likely to obtain lower interest rates because they are perceived as low risk borrowers. This is in accordance with the Equal Credit Opportunity Act which states that credit scores must be statistically and demonstrably sound. In other words, credit scoring models must operate and rank order consumers depending on their level of credit risk.
Using credit scores to determine different rates and terms for loans is not a new phenomena. Lending industries have been utilizing such scoring systems for decades, often referred to as “risk based lending”. The terms are based on the riskiness level of the prospective borrower, defined by their credit scores.
Credit Scores and Interest Rates
Fortunately, credit scores and their respective interest rates can work in your favor. Most importantly, you do not have to have a perfect credit score of 850 to achieve the best rates lenders have to offer. Usually any score above 760 can provide you with the best rates. It is also important to note that you do not need to have a 760 score from all three credit reporting agencies in order to get a competitive rate. Even with a score of 700, within the 50th percentile nationally, it is likely that you will receive a competitive rate offer from most lenders. With this information in mind, remember that the goal is to improve your credit score as much as you can because the journey can be just as financially beneficial as the endpoint.