You have seen the commercials and heard the radio jingles, so by now you know that a good credit score is important. But what is a good credit score? Generally, anything above 700 is considered a good FICO credit score.
But that is not the end of the story. The reality is that a good credit score doesn’t guarantee a loan or mean that you are in good financial shape. A good credit score just gives the lender another piece of information to help determine your credit worthiness. Your ability to get a loan depends on many factors, including your credit report, your credit history, amount of available credit, credit utilization, and other factors. Many lenders even use specific types of credit scores for certain loans. For example, the FICO 8 score is often used by mortgage companies to determine one’s ability to qualify for a mortgage.
Expert Tip: Get a free copy of your credit score.
What is a Good Credit Score Range?
Your credit score is determined by a proprietary mathematical formula. There are many different versions of credit scores, but the most commonly referenced is the FICO credit score, which is considered the industry standard. Your credit score is based on a weighted formula which includes your payment history, amounts owed, age of credit history, recent loans, and the types of credit you have. The FICO credit scores range from 300 to 850 and a good credit score range is considered 700 – 850. Here are more credit score ranges and their ratings.
FICO credit sore ranges:
- FICO credit score range: 300 – 850
- Good credit score: above 700
- Average credit score: 680 – 700 (depending on source)
- Poor credit score: Below 620
Why You Need a Good Credit Score
The FreeCreditReport.com commercials want you to believe you need a good credit score to drive a nice car and pick up chicks. Unfortunately, that’s not quite true. A good or bad credit score doesn’t guarantee a loan or necessarily prevent you from getting a loan. A good credit score will make it easier to be approved for a loan, allow you to have more available credit, and qualify you for lower interest rates when you are approved for a loan. And low interest rates can make a HUGE difference over the life of a loan.
How a good or bad credit score affects interest rates. Loans are available to almost anyone, even people with a poor credit score. But the terms and size of the loan will vary widely. The difference will come in the form of the required down payment or the interest rate you will have to pay. Let’s look at some examples of how good and poor credit scores will affect your payment structure on a mortgage, then on an auto loan. There is a substantial difference in monthly payments between high and poor credit scores, and the payments over the life of the loan should be enough to convince you that a good credit score is valuable!
Effect of Credit Score on 30 Year Fixed Mortgage Rates
The score ranges and interest rates below come directly from the MyFICO website. There are three examples given for credit score ranges and interest rates, one is for auto loans and the other compares credit score and interest rate ranges for 15 and 30 year mortgages. The example below is from the 30 year fixed mortgage at $300,000:
|FICO® score||APR||Monthly Mortgage Payment|
Comparing good credit mortgage rates and bad credit mortgage rates. Using the numbers above, you will notice there isn’t a big difference in the monthly payment from the top credit score to the second tier credit score range of 700-759 (remember anything over 700 is generally considered a good credit score range). Once you start dropping into the lower tier credit score ranges, you will see a large monthly difference in your payments. But thinking in terms of monthly payments can be an expensive way to think, especially when you consider that this is for a 30 year mortgage.
Even with the best credit score, making minimum payments on a 30 year mortgage means paying $256,564.15 in interest over the life of the loan. Paying 6.234% interest over the life of a 30 year mortgage equates to paying $363,851.12 in total interest. To put it another way, that monthly difference of $298 equals a difference of over $107,000 over the life of the loan.
How Your Credit Score Affects Auto Loans
Using the same concept as we used above, let’s examine the how your credit score range affects your monthly auto payments. The MyFICO website references a 36 month fixed rate auto loan for $25,000.
|FICO® score||APR||Monthly Auto Payment|
Comparing good credit auto loan rates and bad credit auto loan rates. As you can see, the monthly difference between the good credit score range and a poor credit score range is $155, or over $5,500 for the life of the loan.
How Your Credit Score Can Impact Other Areas of Your Life
Some other companies or industries may also check your credit history or credit score. Here are some of the ways they may use your score:
- Employers: Whether it’s right or wrong, employers believe that financial health is a good determinant of whether a potential employee will steal. Reviewing a credit history has become standard in background investigations, especially if they are security related, because someone in difficult financial shape may be tempted by bribes. While bankruptcy can’t be a factor in a hiring decision, everything else in the history is fair game.
- Insurance companies: It’s unclear why insurance companies use credit in their decisions but the fact they do is very clear. The lower your credit score, the higher your premiums will be. For whatever reason, their actuaries have determined that lower scores mean more claims.
- Landlords: Landlords have been checking credit scores and histories since the beginning of time because they’re essentially “lending” you the value of rent each month. If you’re unable to regularly meet other obligations, you might not be able to make rent and that’s a problem. This same logic applies to service contracts, like cable or cell phone service.
What is Bad Credit Score?
Have a poor credit score? Credit scores under 620 are often considered sub-prime loans, and come with more risk to the lender. Borrowers with credit scores in this range often pay substantially higher interest rates. If you fall below the sub-prime loan cutoff limit, it may be best to try and improve your credit score before applying for a loan. You may find it easier to obtain a loan and the terms will likely be better.
Remember, not all is lost. As we mentioned above, you can almost always find someone to give you a loan if you need one. You will see a difference in the terms of the loan, though. You may be required to pay a larger down payment or higher interest rates to get the loan you are seeking.
Your Credit Score is Important
Like it or not, your credit score plays an important role in your ability to obtain a loan, the amount of available credit you can carry, and the interest rates you will pay. If you are considering applying for a loan in the near future it is probably a good idea to know your credit score and try to improve it before applying for the loan.