Have you ever applied for a loan from a bank and wondered why you received a certain interest rate? I remember when I applied for a loan to buy my first house. I’d taken out a few student loans that I paid off, but I was still making payments on my auto loan, and had a couple of open credit cards. Since I’d never had a late payment, I assumed I would qualify for the lowest advertised interest rate. I had no idea what my credit score was.
After submitting my loan application, to my surprise, I wasn’t offered the lowest rate. “But why?” I asked the mortgage loan officer. I had never missed a payment on any of my loans or credit cards. Isn’t that what they should be concerned about? They told me my credit score wasn’t high enough to warrant their lowest rate.
After some research, I discovered the quality of the applicant’s credit score is one of the most important factors lenders consider when deciding to whether to extend credit. It’s also taken into account when deciding what terms and rates are offered. And, that a person’s credit report determines the person’s credit score.
What is a credit score?
A credit score is a numerical representation of your credit risk. That essentially means how likely you are to pay back the loan. Credit scores range from 300 to 850, and are used by lenders to easily and objectively evaluate your credit risk. Higher scores usually mean less credit risk. Most lenders require a minimum credit score before they offer you a loan. They also create credit score tiers used to determine what interest rate they offer. That’s why you should have as high a credit score as possible before applying for any loan, regardless of type.
What can you do to raise your credit score?
The first thing to know is it takes time to improve your credit score. While you can ruin your credit score very quickly, it can take several years of good behavior to increase it. This is especially true if you have had a credit mishap like a missed payment. Below are six suggestions to help you improve (or maintain) your credit score.
- Review your credit report annually. At least once per year, check your credit report for accuracy, and that nothing is on it that shouldn’t be. Reviewing your credit report can also help you protect yourself from identify theft, which could ruin your good credit. If you have any questions about your credit report, or wish to dispute an error, immediately contact the credit reporting agency that issued the report. Tip: You can get one free credit report per year from each of the three major credit reporting agencies simply by visiting www.AnnualCreditReport.com and requesting your free credit report. Unfortunately, you won’t find your credit score on your credit report. Some credit card providers have partnerships with one of the three large credit bureaus to provide free credit scores to their customers. Check to see if your credit card provider has such an arrangement.
- Pay your bills on time. This may seem like a no-brainer, but it’s important to make your payments on time, as any late or missed payments are likely reported to the credit bureaus. If you’ve missed a payment, get your account current and stay current. The longer you go without missing a payment, the more your credit score should increase.
- Pay down your credit card balances. When your credit cards have high balances, it gives you a high debt-to-credit ratio (also known as utilization rate) and can signal credit providers and lenders that you are facing financial difficulty.Tip: Don’t move your balance from one credit card to another as this won’t help.
- Only apply for a new loan or credit card when you truly need one. When you apply for a new credit card, you add a “hard inquiry” to your credit report, which causes your credit score to drop slightly in the short term. You may also be adding more new debt than you can afford to repay, both of which could negatively impact your credit.
- Enroll in automatic payments. Enroll in automatic payments through your credit card and loan providers to have payments automatically debited from your bank account. Most student loan providers offer an interest rate discount for automatic payments, so there is that added benefit as well. Tip: When setting up automatic payments on credit cards, if you choose to make only the minimum required payment, you could be rolling over large balances each month and get hit with high interest charges.
How Does It All Help?
Having a clean credit report and a high credit score can help you in many ways, including lowering the cost of borrowing, obtaining insurance, setting up housing utilities, getting a job offer, and more. If you are having trouble making your payments, be sure to speak with your credit card provider or lender before you miss a payment. It’s in their best interest to work with you to find a mutually agreeable solution, so you may be able to work out an arrangement that meets your needs.