How Do Credit Scores Affect Interest Rates?

Based on what’s called your “credit history” – that is, the way you have behaved when extending credit in the past – the three major credit bureaus have devised a system which lets lenders evaluate your potential as a credit risk in the future. This system involves analyzing the data that the credit bureaus have on file for you, including your payment history on credit cards, and whether you have any outstanding debts. Using this information, the credit bureaus come up with what is called your “credit score.” This is a three-digit number that tells the bank what sort of credit risk you are. When you apply for a loan, or any other form of credit, the bank uses your credit score to evaluate the potential risk you may pose to them as a borrower.

Your credit score determines whether or not you qualify for a loan, and at what rate of interest you can borrow. Let’s say you want to buy a car, apply for a mortgage on your home, or get a credit card in your name. When you apply for the credit, your bank uses your credit score to evaluate the potential risk of lending money to you. If you are what they call a “sub prime” borrower – which means that you have a low credit score – your interest rate will be higher, because the bank is assuming more of a risk in lending money to you.

For example, let’s say you are applying for a mortgage. If you have a credit score of 760 – widely considered a “good” credit rating. Your credit rating qualifies you for a 6.11% interest rate on a 30 year, $300,000 mortgage. Let’s say another person applies for the same mortgage, and they have a credit rating of 620 – the low end of “average.” That borrower might be quoted an interest rate of 7.42% – over a full percentage point higher. “Subprime” borrowers – those with credit scores below 620 – receive even higher interest rates, if they even qualify for a mortgage at all. Over 30 years, the difference in interest rate can make a huge difference in how much each prospective mortgage holder pays out over time.

Having a good credit score means you get better rates, higher credit limits, and other benefits. A lower interest rate translates to a very real savings to you over time. If you are considering applying for a mortgage, a credit card, or an auto loan – it pays to make sure that your credit rating is as spotless as you can make it.