With mortgage rates at historic lows and credit card companies doing everything they can to get your business, there’s no better time to learn about interest rates and your credit score. A strong credit score can help you control your finances and stop you from going over budget.
You might be asking yourself, “What is credit?” Let me preface this with a quick introduction to credit scoring. Scores in the United States are calculated by the Fair Isaac Corporation (FICO) and can fall anywhere between 300 and 850, although the majority are in the range of 650 to 799. The FICO algorithm used in calculating the score is a closely guarded secret, but some basic information is revealed to help consumers build and improve their score. In essence, there are 5 elements that go into calculating a credit score: payment history, amounts owed, length of credit history, new credit, and types of credit used.
- There is no definitive answer to the golden number that will guarantee you the best loan rates, but research has given us some guidelines.
- Credit scores are defined in ranges, and anything above 750 is treated as ‘A+’ or ‘risk-free.’
- A credit score below 620 will usually result in increased scrutiny from lenders.
- Your credit score is not the only thing lenders take into account; they also look at your entire credit report, as well as your income and net worth.
How to improve your credit score
- Again, the mysteries of FICO’s operations prevail here: there’s no way to guarantee a boost in your credit score; however, there are certainly ways to get on the right track.
- The most important advice here is to pay all your outstanding credit before the due date - a single late payment can lower your score up to 110 points!
- If you know you’ll be applying for a loan soon, don’t apply for anything that would result in a credit check beforehand - inquiries in your credit report count against your score.
- Sign up for credit cards. This one is a bit counter intuitive, but your credit score can’t improve if you’ve never had credit, so apply for credit in moderation to start building credit.
- Don’t use all your available credit. The second biggest factor of your score is the ‘amounts owed,’ and this takes into account your credit utilization. Strike the right balance between available credit and expenditures.
Should you shop around for loans?
- The short answer: Yes, absolutely!
- Although credit inquiries hurt your credit, FICO takes into account that you may be comparison shopping and will count multiple inquiries of the same type as one, as long as they happened around the same time.
- I can’t stress the importance of having good credit enough here. Qualifying for the most competitive rates is all about proving to lenders that you are responsible enough to pay back the loan.
- Here’s a scenario: you’re looking for a $250,000 30-year fixed mortgage. The first bank offers you a rate of 5% based on your credit history and your ability to repay the loan. This comes to $1,342.05 per month. Now you go to another bank, which offers you 4.5%, a monthly payment of $1,266.71. Just 0.5% saved you $75.35/month or $27,122.68 in total!
That’s almost $1,000 a year in savings, just from taking some extra time to shop around. Even if you already have a mortgage, you can save money today by refinancing in this lender’s market. If you’re living on a tight budget, you can stop worrying about money with all the savings. Now that you know how to bring your credit up, the biggest problem is what to do with all the extra money!