Why Your Credit Score Matters and How it Can Save You Tens of Thousands of Dollars
Understanding Personal Finance: Credit Scores
Some of the catchiest commercials I watched growing up were the ones from companies offering “Free Credit Reports” (here’s a link with some highlights). I laugh now at why these companies used to air commercials about Credit Reports on Cartoon Network or Nickelodeon. I guess that they didn’t want me to turn into one of the very talented musical guys who couldn’t get a loan for a house and had to live in his parent’s basement. Well 15 years later, I remember you Free Credit Report dude, and hopefully, I can save others from a similar fate.
(PS — Nothing wrong about living in your parents’ basement, I would love to not pay rent. I’m talking about the not getting approved for a loan part, that would suck)
What is a Credit Score?
In simple terms, your credit score is how a financial institution, lender, and a variety of other people gauge how likely you are to pay back your debts. In essence, your credit score is rooted in trust. It’s kind of like real life, let’s say 2 different people ask to borrow $20 from you. One person, Jack, is known to be wavy with the word “borrow,” you’ve known him for years and can’t remember a time where they actually paid back the $20 they borrowed. Another person, Patricia, you’ve also known for years, and know that if she asks for $20 in a few days you usually have a Venmo notification on your phone with the $20 back. Given that your friendship level with both people is the same, in a strictly financial sense who would you rather lend $20 too? Patricia, she’s the homie who pays you back.
We all have internal trust systems that judge our acquaintances and friends with all of their actions, and most of this has been built up over the years. This is essentially what financial institutions attempt to do with credit scores. They have no idea who you are as a person, but they can gauge your financial trustworthiness based on your history of borrowing money! Your credit score is kind of like your “trust” rating to these institutions and the higher it is, the more money they’re willing to lend, the better the terms, and the lower the interest rate.
There are 3 Major Credit Bureaus: Experian, Equifax, and TransUnion, where they rate your credit score from 300 to 850 points. I won’t get into the details of the exact facets that make up your score in this post, I’ll have a detailed breakdown in a later post, but in the meantime, you can read this. Here’s the breakdown of what each score generally means when a financial institution sees it!
Note — Some Financial Institutions may have different breakdowns and ranges
Why does my Credit Score Matter?
Okay, I get what a credit score is now, but why should I care about my credit score? Well, those financial institutions I talk about have a lot of power over our plans in life. Whether or not that’s okay, is a different issue, the fact of the matter is that these institutions control almost everyone’s access to loans, mortgages, credit cards, and other financial services that are critical for most people. Here’s a quick list of some of the things credit scores have an effect on:
- Mortgage on a House: the amount approved and interest rate
- Credit Cards: approval, credit line given, and interest rate
- Loans (Car loans, large loans, small loans, all kinds of loans, like all loans): approval, the amount approved, and interest rate
- Getting a Job: More than 50% of employers check your credit score before hiring you
- Renting a Place: More than 50% of landlords check your credit score before letting you rent their place
- Mobile Phone Providers: T-Mobile, Verizon, AT&T, and Sprint probably won’t give you that nice phone deal if you have a bad score
So unless you have enough cash to pay for everything up front, work for yourself, and fully own your home / live in your parents’ basement, you should probably care about your credit score. A very easy thing to look at is approval of a loan/mortgage in general. Have money saved up for a downpayment on the house of your dreams? Well, you won’t get approved for a mortgage if you have a bad credit score! Trying to get a new credit card to pay for a big purchase? Well, you won’t get approved for a credit card if you have a bad credit score! Want to take a car loan out to buy a new car after yours broke down? Well, you won’t get approved for a car loan if you have a bad credit score!
The scariest thing isn’t even approval; it’s the INTEREST RATE you get depending on your credit score. For the most part, as long as you have a generally okay score and the financial institution at least somewhat trusts that you’ll pay the money back, they’ll approve you. Now they’ll mitigate the risks of losing money for themselves by giving you a higher interest rate because of your so-so credit score.
Let’s look at an example of a simple $250,000 mortgage for a house on a 30-year fixed interest loan and see the difference in how much money you would pay depending on different interest rates and credit scores.
With just this table alone, you can see how much more interest you would pay on a standard $250,000 mortgage just based on your credit score. If you have a top tier score of 750+, which is about 20% of Americans, you would be paying $80,000 LESS than someone with a credit score of 600–624 over the life of the mortgage. If you’re a person who does your budget every month, that’s over $200 in savings for simply maintaining a great credit score, which is doable by everyone. This is just one of the many things that depend on your credit score. Tens of millions of Americans are paying hundreds and thousands of dollars more on bills because of high-interest rates every year. Taking into account credit cards, car loans, and all other loans you could save a lot of money by having a high credit score. Of course, the best way to save money is to not have any loans at all, but let’s be realistic, the average American has at least some debt and we should be trying our best to minimize the amount of money we pay for interest.
How do I check and make my Credit Score Better?
The easiest way to check your credit score is with your bank, credit card company, or by using something like Credit Karma. Will have a post coming out soon on what factors go into your credit score and how to make it better! For now, knowing your credit score is the first step towards being fiscally responsible with debt. Let’s make it happen.
Originally published at www.savvysavior.com on January 8, 2019.
