How Can a Credit Score Affect Your Finance?

The following is a guest post from Ross Jackson, a blogger who likes helping consumers understand the difficult terrain that is credit, debt, and finance. 

How Can a Credit Score Affect Your Finances?

Most individuals do not understand how a credit score can directly affect their financial life. This score is a number that helps a company decide if, you as a customer, are a good fit for their business model.

This three digit number is one of many elements that is looked at to establish whether a person may or may not be a risk to their business. Combined with other factors like employment history, income, and savings, a credit score will influence a lender to decide whether to lend you money.

A bad history or score can affect your business with lenders and lead to higher interest rates or less favorable terms. It might also lead to higher auto insurance premiums, more difficulty renting a property, and even affect your ability to be hired.

The Negatives of a Poor Score

If you have a low score it can mean that you will have less access to new credit. You are more likely to be denied for a car loan, mortgage, or new credit card, because your score does not fit the profile of someone who is financially responsible.

Your credit score is not the only factor when you apply for a loan, but it is very important. Other aspects of your finances, like income, can also be a huge factor. Your ability to pay back a loan is the absolute, most important thing to a lender. Lenders make their money with fees and interest payments. It would be bad business for them to work with someone who is at high risk of not paying them back.

A potential borrower with a score that is 800 or higher might sound ideal. But, if this person has no stable source of income, no company in the world would lend them money. This is also true in the opposite sense. If your credit is damaged from a bankruptcy or default in the past, but you have a solid job history and great income, you might still be approved.

Credit scores move and change as new financial events take place in your life. Bad scores can affect you, but there is always the possibility of improvement.

If you change the habits that led you towards poor credit, your score can improve dramatically. Here is an article that shows you exactly what number is considered a good score, and what type of number needs improvement.

Higher Interest Rates

Having a very low credit score is a signal to companies that you are a potential risk. Businesses will try to offset this risk by raising your interest rate. The rate these companies will quote you will also depend on multiple factors, but your credit score is a big one. An example of this, shows in the home loan rates at MyFico.

The difference in interest rates between someone who has a 760 credit score and a 660 score would be $120/month on a $300,000 loan. This amount may not seem that much at first, but over 30 years the difference in cost would add up to $37,500. This amount is enough to purchase 2 vehicles. It would be completely wasted in extra interest payments because your score was lower than it could be.

New Credit Cards

Obtaining new credit cards will also be more difficult with a poor score, especially in today’s economic climate. Getting a new card or a limit increase is not as easy as it was before the credit crunch. Even with a good job and good credit, companies are giving out a lot less credit than they did before.

Before the mortgage crisis, people with little income had easy access to credit. But, things have since changed with the decline of the economy. The total amount of loans given out are down, but as of this year, surprisingly sub-prime mortgage approvals are up 10%. This may signal a trend towards more easily available credit.

Auto Insurance Premiums

Auto insurance premiums are also affected by a low score. If you don’t have a very good payment history, it may also mean that you will be late to pay your premiums. If an insurance company believes this may happen, you will end up paying for it with higher rates.

Insurance companies have also noticed that people with poor scores tend to file more claims. People who have a better financial history usually have less accidents and get less tickets. There are also some other factors that affect your premiums besides your credit score. This would include your age, miles you drive, and education level.

Some consumer groups feel that the practice of using credit to determine premiums is unfair. But according to GMAC Insurance, “92 percent of all insurance companies use credit information when underwriting new policies”. This practice is very common and unlikely to change soon.

It is important to note that, your credit score does not exist in a vacuum.

We often think that a good credit score guarantees us a loan or credit card, but this is not the case. Your score is only one piece of the puzzle. The more well-rounded you appear to be financially, the better chance you have of getting a loan with a great rate or qualifying for a low-interest credit card.

If you do have a poor score, it can always be improved. Paying off debts and paying bills on time, will eventually move your score in the right direction. Adopting good financial habits now can set you up financially for the future.

SB’s thought: Credit score for many is a mystic terminology, but in-fact understanding credit score is a simple task, you can achieve within a few minutes. I suggest you read my post ‘The complete guide to understand credit score‘.