Seeking a Loan: Know Your Credit Score
Are You Planning a Major Purchase?
At some point in your financial life, you will need to borrow money for major purchases that you want, whether a new car or a new home. Before you knock on a lender’s door, you should find out what your credit score is. That credit score will either enable you to borrow at a desirable rate or it will add more cost to your loan. If you are planning on making a major purchase in the coming months, it is crucial to evaluate your credit score beforehand. This will leave time for you to work on improving your credit score to receive more favorable loan terms, and ahead of many loan applicants who don’t grasp the importance of the credit score.
Added Costs of a Poor Score
Around 70 percent of consumers don’t realize how costly it is to have a low credit score. According to a study by the Consumer Federation of America, a nonprofit consumer agency, and VantageScore Solutions, if your credit score is below 600, you could be paying an extra $5,000 more on a $20,000, 60-month car loan. On a 30-year mortgage, a low credit score can add as much as three full percentage points to the interest rate. This is a difference that can cost a family as much as $2,400 yearly or $72,000 over the life of a $100,000 mortgage.
With the economic turmoil of the last few years, many consumers have been adversely affected. Credit scores sank to new lows during the deep recession of 2008-2009. The Fair Isaac Corporation of the FICO score system revealed that over 25 percent of consumers (43.4 million people) had scores below 600, putting them in the category of poor risks where loans are denied or costly.
Comparison Shopping Doesn’t Lower a Score
One of the biggest misconceptions about credit scores is that a consumer lowers his or her credit score by comparison shopping. Quite to the contrary, every prospective borrower needs to get out and talk to several lenders to compare their loans. It will not affect their credit score, and it should help them find the lender with the best terms for their loans.
When talking to lenders, find out what type of scoring system they use. If your score is a FICO number, the range will be from 300 to 800, with a median score of 622. Since other methods of computing credit scores exist beside the well-known FICO score. You may think that you have a high score at 750, but if the range is from 150 to 934 (the scoring range at the TransUnion credit bureau) that number no longer looks so good.
Credit Card Balances
Another assumption was that balances on your credit card should be kept at less than 50 percent of the available line of credit. In fact, you should use no more than 10 percent of your credit line in order to earn the highest credit score. For example, if your line of credit on a card is $10,000, you need to keep your balance at $1,000 or less.
Your credit score is not hurt by paying off a credit card, but it can be detrimentally affected by expensive purchases. Be careful of what you charge before applying for a car loan or a mortgage, as a large increase to the amount owed on your card will be looked at unfavorably by lenders.
Paying Cash vs. Charging
A good credit score can be built with charge cards, since a record of financial history is needed to create a credit score. If a consumer pays cash for all his or her purchases, there will be no record of the transactions at a credit bureau. It is better to keep a few charge card accounts open to record timely payments, which establishes a credit score and a financial record. Potential lenders want to see timely payments on other accounts to know that you have been creditworthy and will likely pay them back.
Reference:
- 1. Consumer Federation of America, Credit Scores Are Vital to Your Health,
http://www.consumerfed.org/elements/www.consumerfed.org/file/finance/yourcreditscore.pdf