Wednesday, January 14, 2009

Your Most Important Score: Credit History

This post was featured on this week's Carnival of Debt Reduction. Go check it out!

Have you ever wondered why your friends are paying less interest for their mortgage while you are stuck with a high rate? Probably because of your credit score. When you get a loan, the first thing that comes into account is your credit score. Credit scores can range from 300-850. The higher the score, the better. You are scored based on your credit history; whether on past credit card loan, mortgages and car loans, you paid your bills promptly. Why does your credit score matter? Well, let’s look at it from the creditors’ point of view. They are lending you substantial sums of money, with no guarantee that you will pay it back. Your credit score gives them an idea of how reliable you are. With a high credit score they will give you a low interest rate because they are not taking much of a risk lending money to you. If you have a low credit score, the creditor is taking a risk by lending you money. In return for taking a risk on you they expect a higher reward, which comes in the form of higher interest rates. Also, credit doesn’t only affect your potential for loans. Did you know employers are legally allowed to deny an applicant for a job if they have a low credit score? It makes you appear to be irresponsible, and nobody wants to hire an irresponsible employee. Now a low credit score is not only costing you more money in interest, but costing you earnings as well!

And don’t be fooled into thinking you can just not have a credit card and you’ll be fine. Your credit doesn’t start at a perfect score, and then drop as you make mistakes. You have to build your credit by showing that you can pay back the loans you take out. This is one reason I recommend that parents cosign on a credit card with their children as soon as they qualify. The card doesn’t have to have a high limit and ideally it would be best if it was just used for small purchases that would be paid back in full at the end of every month. It is a good way to build up credit before entering the real world.

Don’t believe your credit score can make THAT big of a difference? Just look at the numbers. These are according to the site myfico, which deals with credit scores and credit education. On a 30 year fixed mortgage of $500,000, a person in the highest bracket of credit, 760-850, would get a rate of 6.274 which translates to $3086 a month. On the other hand, a person in the 620-639 bracket would get a rate of 7.863% or $3621 a month. With a score of just 121 points higher, you could save

  • $535 a month
  • $6,420 a year
  • $64,200 over ten years
  • $192,600 over the entire 30 year mortgage.

Think of all the things you could do with $192,600. You could buy that Ferrari you always wanted :) By keeping your credit score high, you could save hundreds of thousands of dollars. And this is just one loan. Imagine if your credit cards, car loans, etc all had the same savings!

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