4 Reasons You Need To Understand And Watch Credit Score

A surprising number of people don’t know their credit score or, if they know it, they haven’t checked it recently. Even more don’t understand how rating agencies determine that score and how it is used.

For instance, according to a 2023 survey, 30.6% of consumers did not know their credit score. Additionally, 38.1% only somewhat understood the factors that determine scores, while 22.6% did not know at all.

Your credit score can have a surprisingly large impact on your financial situation and your life more generally. This is not something you want to neglect.

Even worse, if you have bad credit, you might not even realize the serious economic impact you’re suffering as a result. Knowing your credit score can help you immensely in improving your life choices and your financial situation.

What Credit Scores Affect

Your credit score can impact more than just access to loans and credit cards. Most people understand this in principle, if not the details. However, your credit score can determine whether you get that job you really want or that lovely apartment next to the park. It can even impact what you pay for your auto insurance.

1. Loans and Loan Terms

Lenders use your credit score to evaluate your creditworthiness when you apply for loans. At the most basic level, that means that you are more likely to be approved for a loan if you have a solid credit score. If you have a low credit score, you’re more likely to be refused.

But banks and other mortgage lenders also use your credit score through a system known as risk-based pricing, or RBP, to determine what interest rate you will pay.

The long and short of it is that if you have a lower credit score, you are assessed to be at a higher risk of not repaying your loan. That higher risk is built into higher prices to cover the risk.

According to FICO, someone with a 720 score could expect a 6.658% interest rate on a $250,000 mortgage, while a 620-639 score means paying 8.025%. That translates to over $83,700 more in interest charges over the lifetime of a 30-year fixed loan.

In terms of monthly payments, that’s the difference between paying $1,600 and $1,839. Almost $250 more per month!

Even a small difference in rates can equal thousands of dollars in interest savings on a mortgage.

2. Job Applications

Some employers check the credit reports of job applicants as part of the hiring process. While they won’t see your exact score, your report gives them an idea of how responsibly you manage debt.

A good credit history can give you an advantage over other applicants. Checking your credit score can give you a snapshot of your credit health. If a low credit score turns up, that’s a sign that you should look more deeply into your credit report.

It may turn out to be nothing adverse – even taking out a new loan can temporarily lower your score and an employer won’t find anything untoward in that. But it may indicate something that you need to quickly fix.

3. Renting an Apartment or House

Just as with employers, landlords will often check potential tenants’ credit reports to gauge financial responsibility. They are giving you access to their property and want to know that they won’t have to chase after you for overdue rent every month.

It can also be an indicator of whether you will come up with other responsibility-related problems that will mean more expenses and work for them.

For those reasons, applicants with good credit are seen as more reliable and may have an easier time getting approved and avoiding large security deposits.

Scores as low as 620 often meet the minimum requirements for rentals, but 700+ scores will put you at the front of the line on quality apartments.

4. Auto and Home Insurance Rates

In most states, insurance companies use credit-based insurance scores to calculate the premiums you have to pay. In some states, such as California, Hawaii, Maryland, Michigan, and Massachusetts, this practice is prohibited or restricted.

In those states that permit it, people with the highest credit scores can save twice as much on premiums as those with no credit history.

According to FICO, one of the main providers of credit scores, 85% of household insurance companies and 95% of auto insurance companies use credit scores.

An Arkansas study, for instance, found that positive credit information led to 50% of premiums decreasing.

However, it is important to state that credit scores are not the only determining factor in eligibility and rates. You cannot be denied insurance because of your credit score.

How Credit Scores Are Determined

While it is important to understand, and many people do, that credit scores can impact your life in surprising and indirect ways. It is also important to understand who those scores are arrived at and who is responsible for them.

That way, if you have a problematic score, you have the possibility of improving it – and your life in the process.

First, credit scores condense the information on your credit report into a three-digit number, which lenders use to assess your ability to repay debts. The most commonly used scores are the FICO score and the VantageScore.

1. FICO and VantageScore

The FICO score was introduced by Fair Isaac Corporation in 1989 and is used in over 90% of lending decisions. The VantageScore was launched in 2006 by the three major credit bureaus as a competitor to FICO.

It has gained traction recently among some lenders. Both score types use the same 300 to 850 scale.

2. What Impacts Your Score

While the exact formulas are proprietary, several key factors are known to influence your FICO and VantageScore, including:

Payment history – whether you pay bills on time, the most important factor, influencing up to 35% of a score for FICO and 40% for VantageScore’s calculations.
Credit utilization – the amount of available credit you’re using; keep balances under 30% of limits. This is why taking out a new, large loan will cause a temporary drop in your credit rating until you begin repayment and it rebuilds your score.
Length of credit history – scores improve with a longer history of responsible usage.
Mix of credit types – both revolving (credit cards) and installment (mortgage, auto) credit matter.
Recent applications for new credit – too many close together can indicate higher risk.

Unpaid medical debt is also excluded from the latest FICO and VantageScore versions when calculating scores. Factors like age, employment history, and income level do not affect your credit scores.

3. Checking Your Credit Score

Getting your actual credit score sometimes requires paying a fee, while accessing your credit record does not. Your credit record doesn’t include your score and it is the former that employers and landlords can access.

Options to check your credit score include:

Purchasing your score from myFICO.com, along with a credit report, will cost you $20. VantageScore’s credit score can now be accessed for free directly from their website.
Checking if your bank or credit card provides customers with free monthly access.
Using a personal finance website or app that supplies free scores.
Getting your score along with your credit report if you are denied credit.

You can get your reports for free weekly by using AnnualCreditReport.com without seeing your scores. Checking reports regularly can help you dispute any inaccuracies that may be negatively impacting your scores.

It can also be a good practice before going into a bank to ask for a loan or prior to applying for a new job.

4. Improving a Poor Credit Score

If you discover that your credit score is lower than you expected, don’t panic. There are many ways to raise that score over time. That is true if you are new to using credit or if you have had debt challenges recently.

Here are some tips on things to do:

Make all bill payments on time – this is the most crucial factor.
Pay down credit card and loan balances so that they never remain above 30% of total available credit.
Be cautious about opening many new credit accounts close together
Build a history – keep accounts open even if not in use
Dispute and fix errors on your credit reports

If you find yourself struggling with overhanging debt, it can be worth speaking to a financial counselor to help you figure out a repayment plan. It’s not always easy but it usually is possible with some discipline, help, and determination.

You can also build credit from no score using secured credit cards or credit builder loans. Or, you can have someone with a high credit score such as a parent, add you as a registered user to their credit card.

As with dealing with a heavy debt load, getting guidance from a nonprofit credit counselor can help create a plan to boost your score through responsible money management.

The Takeaway

It should be obvious that your credit score can significantly influence your finances and life. With great credit, doors open through better loan rates, credit card rewards programs, insurance discounts, and more.

Job and apartment applications also go more smoothly. Checking your score regularly and keeping it high pays dividends now and down the road. Don’t leave things to chance.

Author Bio:
Meet Alex Richardson: once a financial advisor, now your friendly guide through the money maze. In his articles, Alex turns tricky financial jargon into clear, everyday advice. He’s all about helping you get savvy with your finances, one article at a time.