Guest Blog by Bridget Venus Grimes, CFP®
What’s your credit score? And why does it matter?
I recently met with a banker who told me that she had to decline a loan to a small business since the credit score for the business owner was so low. This business owner makes good money. Her company is profitable, but because of a low credit score, she isn’t able to get a loan. Not just a loan with bad terms, but no loan at all.
Having a good credit score is important when it comes to securing loans like a car loan, mortgage, business loan, even a credit card. It’s also incredibly important to get a good interest rate. Here’s an example of how a good credit score can mean better terms on a mortgage and save you considerable money: Having a $200,000 30 year fixed rate mortgage at the rate of 3.3% with excellent credit would mean a monthly payment of $877. However, to borrow the same $200,000 with a 30 year fixed mortgage, but with a credit score of 620-639, you may likely be paying 4.869%. That would result in a monthly payment of $1,061.
Over the life of the loan you would pay an additional $66,343 because of bad credit. That’s a lot of money paid for a bad credit score.
By having a good credit score and getting the lowest interest rate available for a particular loan or credit you can save a good amount of money that can be put towards other goals. Just having the choice of where you’d like to spend that extra money is worth the work to make sure your credit score is good.
So, what is a credit score? And what is a good credit score?
Anyone who has ever had credit has a credit score. It is a way for lenders to evaluate you as a credit risk. Everyone has their own credit score, so if you are married and applying for joint credit, both credit scores are checked. The riskier you look to a lender (meaning the lower your credit score), the less likely you are to get approved for credit or to get good terms.
Credit scores range from 300 to 850. The higher the score, the better the terms. Why does this matter? Because bad loan terms can cost you. A lot. You can check your credit score for free annually at annualcreditreport.com . Rather than focus on your individual number, the range of your credit score is important to determine your level of risk to a lender.
1. 300-629: Bad credit
2. 630-689: Fair credit
3. 690-719: Good credit
4. 720 and above: Excellent credit
Ever wonder where this number comes from? There are five components that add up to your overall credit score. They are: Payment history, How much you owe, Length of credit history, Type of credit, and Number of credit inquiries.
Could your credit score use some improving?
Living within your means, paying bills on time, and using debt wisely all contribute to a healthy financial life. When it comes to managing your debt, these tips will help you improve your credit score.
- Pay your bills on time. Always.
- Keep your credit card balances at less than 30% of your limit.
- Have a credit history. Show that you have paid your bills on time, over a long period of time.
- Have a variety of credit account types.
- Minimize your new credit inquiries.
Credit Scores and Mortgages
We’ve had quite a few folks we know apply for mortgages lately, where a credit score can make a huge difference. Because good terms on a mortgage can save a huge amount of money, we wanted to hear from an expert what mortgage lenders are looking for not only to secure a mortgage but a mortgage with the best interest rates. Mortgage Advisor Sarah Lindsey shared with us how a credit score affects mortgage terms. Sarah told us that when it comes to determining if an applicant qualifies for mortgage financing, lenders look at an individual’s credit score and trending credit data.
A credit score and credit behavior is the fastest way to determine an applicant’s ability to borrow and pay back debt. Lenders will request scores from all three credit bureaus (Experian, Trans Union, Equifax). Mortgage banks will drop the highest and lowest credit score, and loan programs offered will be based on the middle score for the applicant. If there is more than one applicant (for example a married couple will have two applicants), the lowest middle score of all applicants is used. Although there are exceptions to every rule and specialty loan products that can get around others, as a general rule a credit score of 600 is the lowest credit score to have access to loan products. A score of 740+ offers the best rates and access to the most products when it comes to credit qualifying.
Your credit behavior will affect your mortgage terms
A mortgage broker will spend some time combing through your credit report. This includes details of your credit history and credit behavior. Here are some of the behaviors lenders look at:
- Do you pay your credit card balance in full each month? You may be considered less risky than someone who carries a balance forward.
- Do you pay your bills on time? The number of late payments in the last 24 months and on what types of accounts will affect financing options. For example, two or more late payments on a mortgage in 12 months can disqualify a client for any mortgage financing.
- Are you a user of Balance Transfers? If you transfer balances without paying them off, you could be seen as riskier.
- How often do you use credit cards? Bankrate suggests using a credit card once every six months to keep it active.
- What do the public records on your credit report say about you? Are there judgments, liens, short sales, foreclosures?
- What is your debt to income ratio? Debt ratios allowed vary depending on loan product. The better interest rate options will have the lowest qualifying debt ratio requirements.
Once a mortgage lender has a clear picture of where you stand financially based on your credit score and behavior, they’ll be able to assess the available loan products. The higher your score, the less debt you carry or the fewer number of events on your credit, the greater the number of programs available for financing, and the better the terms.
If you find your credit score is not where you’d like it to be, take a good look at your spending behavior and identify the biggest culprits. Payment history and how much debt you have are the biggest contributors to your credit score. A good credit score can absolutely save you money.
If you found this article helpful, please check out the other blogs we’ve written on women and money at WealthChoice Blog.
Bridget Grimes, CFP® is the President of WealthChoice, a boutique financial life planning firm for women executives, and Co-Founder of Equita Financial Network, a collaboration of women-led financial planning firms. She is also the author of the Best Seller Corner Office Choices: The Executive Woman’s Guide to Financial Freedom. She believes in empowering women through education, collaboration, and support so that they have the confidence to take action for a better life.