Finance Globe

U.S. financial and economic topics from several finance writers.
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Your Credit Score Affects Interest Rate

Every debt instrument has an interest rate, typically expressed as an annual percentage rate, or APR. The interest rate the annual amount you pay for borrowing $100. For example, if your APR is 5%, you’d pay $5 in interest annually for every $100 you borrow.

The interest rate isn’t an arbitrary number that banks set up. In fact, you indirectly control the interest you pay when you borrow because your credit score is one of the factors used to set your interest rate. Lower interest rates are ideal because it lowers the cost you pay for borrowing money. Your credit score can either help you get a great rate or can cost you the opportunity to save thousands of dollars.

As you may know, your credit score is a numeric representation of the information in your credit history. The score is a three-digit number that could range from 300 to 850 or 501 to 990 (or some other range) depending on the credit scoring calculation being used. Regardless of the scoring calculation or range, the higher your credit score, the better.

You get a high credit score by borrowing responsibly: not borrowing too much and paying back what you’ve borrowed in a timely manner. On the other hand, a low credit score comes from missing payments, maxing out credit cards, and letting your accounts default so that you have collections, repossession, foreclosure, or judgments on your credit record.

Interest rates are assigned based on the amount of risk you present. If you’re a risky borrower, the creditor charges a higher interest rate for accepting your risk. So, borrowers with a low credit score will generally pay a higher interest rate.

Less risky borrowers, those with good credit scores, often qualify for lower interest rates. In a way, you’re rewarded for good your good behavior with an interest rate that will cost less money.

It’s hard to predict what interest rate you’ll be approved for. It varies by lender and loan product. In general, you can count on getting a competitive interest rate if you have a great credit score. MyFICO.com’s loan savings calculator that gives some insight into credit score variations on mortgages and auto loans. For example, a borrower with a credit score above 760 might get a 3.254% APR on a 30-year fixed mortgage, while someone with a mid-range score around 670 would have a 3.867% APR. And, credit score of 620 would get you a 4.843% interest rate.

It’s similar with credit cards. A recent credit card from U.S. Bank has purchases APR ranging from 13.99% to 23.99%. Borrowers with the best credit history will enjoy the lowest interest rate, while those with lower credit scores will have the higher interest rate, if they’re approved at all.

With credit cards, you can avoid the high cost of a high interest rate by simply paying off your balance in full every month. With loans, it’s not so easy since the balance is repaid over a period of time. If you’re applying for a loan soon, it may be a good idea to spend a few months improving your credit score so you can qualify for a lower rate.
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Monday, 19 August 2019

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