Understanding Credit & Debt
How a good credit score can help you
A top-notch credit score offers more than just bragging rights: it can translate into big financial savings over the course of your lifetime. While different financial institutions measure your creditworthiness in different ways, one widely available assessment is VantageScore. Credit scores on the platform range from 300 to 850, and higher scores can translate into better interest rates, says Jeff Richardson, spokesperson for VantageScore. "Generally speaking, if you have a score above 720, you'll have access to better rates," he says. Scores above 800 are rated as exceptional.
To see how a good credit score can help, it's useful to look at mortgages. Let's say you've achieved an exceptional FICO score (the credit score associated with mortgages) and wanted to apply for a 30-year, fixed-rate, $300,000 mortgage. If your interest rate was 4.4 percent, your monthly mortgage payment would be $1,502.
If your credit score was 200 points lower—a "fair" score—then you might expect a slightly higher rate. Assuming it was 4.9 percent—just a half a percentage point higher—your monthly payments would come out to $1,592, an annual difference of $1,080, or a total difference of more than $32,000 over 30 years.
But you don't need to get a mortgage to reap the benefits of a great credit score. A high score can also get you lower rates on your credit card. “On many of our cards, we offer different tiers of interest rates, ranging by 7-8 percent from the lowest rate to the highest rate," says Tim Ferriter, managing director and head of card acquisitions, Chase. “A better credit score will qualify you for a lower rate."
For that matter, Ferriter notes, credit scores are also a factor in your approval for a credit card.
Bringing up your score
It's never too late to boost your score. A good place to start is with a clear understanding of how a credit score works. Here are the five factors that VantageScore uses to calculate its scores:
- Payment history: According to VantageScore, the most important factor is your payment history. This includes how well you pay your bills on time, whether you have any past due bills or bills in collection and whether you've declared bankruptcy.
- Type and duration of credit: the next most important factor is the type and duration of credit. The longer your accounts have been open, the better. It also helps to have a mix of accounts, including credit cards and loans, like auto loans and mortgages.
- Percent of credit limit used: Also known as "credit utilization," this is another highly influential factor. It's basically the balances you're carrying on all your credit cards compared to the limit on all those cards. For example, if you're carrying a balance of $500 on one credit card and the limit on the card is $5,000, your "utilization" of that credit card is 10 percent. The lower your "amounts owed" or "utilization," the higher your credit score will usually be. As a general rule of thumb, most creditors like your credit utilization to be below 30 percent across all of your accounts
- Total balances: VantageScore considers your total balances and debt to be a "moderately influential" factor in calculating your score. In other words, if you're looking to boost your score, it helps to reduce all of the debt you owe. As an added benefit, this can also lower your credit utilization score!
- Recent credit behavior and inquiries: If you open a lot of accounts in a short period of time, your credit score can take a hit. Part of the reason is that, for each account you open, you will get a "hard" credit inquiry, which can cause a small drop in your score. Richardson points out that the small drop in score also reflects lenders' concerns about changes in the customer's behavior. "If a customer opens a lot of accounts in a short time, the credit model asks if this is a normal expansion of credit, or if they are exposing themselves to debt they cannot repay," he says.
- Available credit: VantageScore also looks at the amount of available credit that you have. "The more you charge up, the less cushion you have in case of an emergency. And you may need that safety net," Richardson explains.
Now that you know how your credit is calculated, you can start thinking about specific steps to bring your score up. Paying down debt, paying your bills on time, and keeping your credit utilization below 30 percent are all good ways to boost your score.
If you stay dedicated to making the right moves, you should see improvements within three to 12 months. That may seem like a long time, but if you consider that a mortgage can span 30 years, waiting for a good interest rate could definitely be worth the wait!
Photo: iStock/Geber86 | Farnoosh Torabi is an award-winning journalist, author, television personality and personal finance expert who provides financial education for Chase Slate.