Why Is A Credit Score Important?
Victoria Araj5-minute read
August 13, 2021
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We’ve all seen the commercials advertising free credit reports and credit reporting apps, but we may automatically filter it out for a number of reasons. Maybe it’s not relevant to us at that exact time, maybe we already have a reliable service or maybe we’re too young to even worry about our credit score. Regardless of your reason for not paying attention to these commercials, you’re likely reading this article because you want to know what these companies are yapping about all that time.
Without further ado, let’s get into the importance of credit scores.
What Is A Credit Score, And Who Reports It?
A credit score is a three-digit number between 300 and 850 that represents your credit history. This number is formulated by the three reporting credit bureaus: TransUnion®, ExperianTMand Equifax®. You could end up having a total of six different credit scores between the three agencies, on account of two different credit scoring systems: FICO® and VantageScore 3.0®. It’s important to note that the most common one used is your FICO® Score.
- 300-579: Poor
- 580-669: Fair
- 670-739: Good
- 740-799: Very Good
- 800-850: Exceptional
To come up with this number, these agencies factor in your payment history, the amount you owe, the length of your credit history, the types of credit you have and any new credit you have. Payment history on loans and credit cards is the largest factor, amounting to 35% of your credit history. The second largest factor is amount owed, which makes up 30%. This is followed by the length of your credit history at 15%, and types of credit as well as new credit that both sit at 10%.
Why Is It Important To Have A Good Credit Score?
First and foremost, your credit score is a demonstration of how risky you are as a borrower. A poor credit score may demonstrate that you have a history of late payments, too much debt or not enough credit in the first place. Lenders won’t be too pumped about loaning to someone who has a long history of being financially untrustworthy.
Because of this, conventional mortgages and government-backed loans alike have rough credit score guidelines loans. For example, a conventional mortgage usually requires a credit score of around 620, and qualification for an FHA mortgage calls for something around 580. While the Department of Veterans Affairs doesn’t have a specific prerequisite set in stone, Rocket Mortgage® requires a minimum credit score of 580 for VA loans.
Even if you do manage to get a loan with a bad credit score, your interest rate could be a bit higher than normal and your terms could be less favorable. This goes for all kinds of loans including, but not limited to, auto loans, mortgages and credit cards.
A slightly higher interest rate may not sound like too big of a deal, but it can be quite damaging to you in the long run. If your interest rate is even marginally bigger than that of someone with a good credit score, that could mean you’ll pay thousands of unnecessary dollars over the life of your loan. That said, your interest rate will depend on not only the state of your credit score but also on how big or small your down payment is. A bigger down payment will (literally) pay off in the long run.
For example, you’ll end up paying around $89,665.14 in interest on a $250,000 loan with a 4.3% interest rate that you’ll pay off over a term of 15 years. With the same loan amount but with an interest rate of 4.6%, that interest payment skyrockets to $96,551.24. To experiment with interest rate pricing, check out Rocket Mortgage's Amortization Calculator.
Although the sample above uses mortgage rates as an example, it’s easy to say that in general, better credit scores will equate to better rates and terms regardless of whatever loan you’re looking into.
More Than Loans
You should remember that your credit score doesn’t just matter when it comes to getting the best rates and terms for loans and credit cards. There are a few other benefits to having a good credit score.
For one, making a solid effort to improve your credit score will not be in vain. As your score improves, your past faults will become less and less significant in determining your overall score. For some key tips on how to improve your score, see below.
Another reason to keep up your credit score is that you might have to pay higher deposits to rent an apartment, or they might not let you in at all. Like trying to get a loan, a bad credit score demonstrates that you’re not as reliable when it comes to making on-time payments and consequently, that you wouldn’t be an ideal tenant.
In addition, you’ll pay less for car insurance with a higher credit score.
Another (and perhaps the most significant non-mortgage) reason for having a good credit score is that you’ll get accepted for the best credit cards out there. That is to say, you’ll get access to cards with low interest rates, awesome rewards and potentially even an introductory 0% annual percentage rate (APR). Ironically, a poor credit score will increase your interest rate and cost you more when it comes to your credit card. If you do manage to get a credit card with a poor credit score, make sure you only spend what you’re able to afford. If you don’t, you’ll risk making your score even worse.
How Can You Improve Or Maintain Your Credit Score Over Time?
Now that you know what a credit score is and how a good one can help you, you’re probably wondering how to improve or maintain it over time. Here are just a few quick tips for keeping your credit score in tip-top shape:
- Pay your monthly bills on time and in full, every time. This goes for your mortgage, car loans, student loans, credit cards and anything else where you’re paying back a lender.
- Don’t spend more than you can afford. It will undoubtedly catch up with you sooner rather than later.
- Diversify your credit, but within reason. Don’t take out more lines of credit than you can handle in an attempt to improve your credit. If you can’t afford it, the dings to your credit score from your ongoing debts will not be worth the 10% that new credit adds to your score.
- Keep the amount you owe less than 30% of your credit limit. For example, if your credit card has a monthly limit of $3,000, try to avoid spending over $900 that month.
Where Can You Find Your Credit Score?
Life is expensive enough. Don’t make it more costly by having a bad credit score.
If you’d like to start getting acquainted with your credit score after reading this article, make a free account today with Rocket HomesSM. Not only is it incredibly easy to set up, but unlike some other credit reporting tools, you won’t ding your credit score by checking it weekly. You can also check out our other articles on credit and personal finance.
Rocket HQSM has partnered with CardRatings for our coverage of credit card products. Rocket HQ and CardRatings may receive a commission from card issuers. Opinions, reviews, analyses & recommendations are the author’s alone, and have not been reviewed, endorsed or approved by any of these entities.
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