How Much is Your Credit Score Costing You?
How Your Credit Score Affects Your Finances
Have you wondered about the significance of your credit score and its impact on your finances? This subject can prove confusing when you hear car dealership commercials claiming that they guarantee financing to customers with good credit, bad credit, and no credit. What’s the big deal? It seems like it won’t stop you from getting a brand new car, so why even stress over your FICO score?
When we slip up and fail to make payments on time, default on student loans, apply for multiple lines of credit, or keep high balances on our credit cards, our credit scores take a hit. And while commercials and mailers tell us we’ll still qualify for car loans and credit cards with high limits, it’s simply not as easy as ignoring our scores and omitting their impact on those lending opportunities.
The Structure of Your Credit Score
Your credit score is comprised of five weighted components: Payment history (35%), Your balances (30%), Length of credit history (15%), Type of credit (10%), and Credit Inquiries (10%). These components serve as your credit profile, which helps lenders determine their risk when they consider extending credit to you. Ultimately, it tells them if you’re likely to make payments on time, if you’ve had a proven record of paying on time, and whether or not you’ve overextended yourself.
Your Borrowing Power
Ultimately, your credit score determines your borrowing power. And borrowing power is much more than just obtaining an item you desire or need. You may still get the car, the personal loan, or the retail credit card, but at what cost? Borrowing power is about the interest rates offered to you, and your ability to avoid paying more for the money you borrowed.
What is a Good Credit Score?
We’ve covered the components of a credit score and how it affects your borrowing power, but what do lenders consider to be a good credit score? Scores have an inverse relationship to interest rates. With scores ranging from 350 to 850, the higher the credit score, the lower your interest rate. The lower your interest rate, the less you pay on top of the original loan amount, which means more opportunities to save money. The following chart breaks down the ranges of credit scores into their subsequent categories:
- 720-850: Excellent
- 680-720: Good
- 640-680: Fair
- 350-640: Poor
Let’s imagine you’ve come upon hard times and you need to take out a personal loan of $2,000 to cover some of your bills and get you back on your feet. If you have a low credit score, ranging from 350-640, you risk denial from lenders. If you are able to procure the loan, you may only qualify with interest rates topping 15%. Let’s say the payment period on the loan is two years. At the end of those two years, you will have paid the lender $2,327.36.
Now let’s say you’ve worked really hard to keep your credit score above 720, which is a favorable score for lenders. You could qualify for a much lower interest rate at 3%. At the end of those 2 years, you would have paid $2,063.10. The cost of the personal loan would save you hundreds of dollars, and you’d be back on your feet without paying much more than the original amount.
While it’s a wonderful goal to make all of your biggest purchases solely with cash and avoiding the need for borrowing any amount of money, you may not always face favorable circumstances. When you want to further your education, purchase a home, replace a vehicle, or take out personal lines of credit, lenders will always refer to your credit score. You can lessen the blow by keeping your interest rates low and keeping your payment as close to the original amount as possible.