Why is it important to have a good credit score?

Why Is It Important to Have a Good Credit Score?

Some folks prefer to never carry any form of debt, while others strategically use certain financial products (like loans or credit cards) to their advantage. Whichever category you fall into, though, the simple fact is that a good credit score can open many doors throughout your life.

Understanding how to build — and then maintain — good credit scores can be a bit tricky, though. So what’s the magic formula for a healthy credit history, what exactly goes into one, and why is it important to have a good credit score in the first place?

Let’s take a look at what makes up a credit score and how you can go about boosting your personal credit rating, regardless of how it will play into your future financial plans.

What your credit shows

Your credit history may come into play anytime you apply for a new loan, open a new credit card, or even shop around for new auto insurance. But why? 

One of the biggest reasons a lender may run a credit check on you is that it provides a pretty good indicator of your past and current credit habits. This tells them a great deal about you and how responsible you are with your financial obligations; in turn, they can determine whether or not you’re likely to manage their account responsibly, as well.

Your credit report is broken down into a few different sections. These show you and potential lenders or creditors:

  • the accounts you’ve had in recent years
  • whether those accounts are currently open or have been closed
  • how long your accounts have been open and active
  • how much monthly payments are/were
  • whether payments have been made on-time
  • how much available credit you have (your credit utilization)
  • how many hard inquiries have been made on your report recently
  • any accounts that may currently be in collections
  • public records, such as bankruptcies or judgments against you

It may also offer your personal information, such as your current and past addresses, your employer(s), and even aliases you may have gone by.

Where to check your credit 

Credit reports are offered by each of the three credit bureaus: Experian, TransUnion, and Equifax. 

Because each creditor chooses where to report your monthly account data, the information in your reports may vary from one bureau to the next. That’s why it’s important to monitor all three for changes and/or errors.

You are able to request one full report from each credit bureau annually, at no charge; the best way to do this is to go to AnnualCreditReport.com (the only government-approved website for your free annual credit report) and complete the process there.

Additionally, you can track your credit (and even your scores) for free through certain online platforms, like Experian. 

Breaking down your credit

The data for calculating your credit score comes from each of your credit reports, which can change from one month to the next. Here’s a rundown of what this report includes and how lenders will use the information.

The type of debt you have (or had)

Lenders and potential creditors will use your report to get an idea of your past and present credit mix, or the various types of credit you’ve managed over the years.

Why is this valuable? Well, if you’re applying for a home mortgage and have only had one low-limit credit card in your life, a lender may worry about your ability to stay on top of a 30-year mortgage loan. However, if you’re a borrower with a mix of credit accounts — such as credit cards, an auto loan, and a business loan — they might be more willing to approve your new loan application. 

Some bureaus (like Experian) also allow you to add monthly services to your credit, which wouldn’t otherwise be reported normally. This may include utility services like your electric or water bill, for instance, or even your monthly rent payments. If you’ve paid those accounts on-time each month, this can do a great job of boosting your score even further.

How long you’ve managed your credit

Your credit history plays a role in your credit score, which demonstrates how long you’ve been maintaining your credit. The longer your accounts have been open and the longer you’ve managed credit-based accounts, the higher your score will be.

Whether you make payments on time

Though each credit score is calculated a little differently, your payment history usually makes up a significant portion of those points.

Whether or not you have made payments on time in the past is one of the biggest indicators of future creditworthiness — at least, as far as a new lender is concerned. The more late payments you’ve had (if any), and the later those payments were (30 days versus 60 or 90 days late), the lower your credit score will be.

How much debt you’re carrying

Your credit report (and in turn, your credit score) will also be affected by the level of debt you’re carrying. Your credit card balances — especially compared with your overall credit limit — will impact your final score, for instance, as will the remaining balance on installment accounts such as a personal loan or home mortgage.

The less debt you have overall, the lower your credit utilization, and the more you’ve paid off on loan balances, the better your chances of having a good credit score.

Who decides your credit score

All of this financial information can be plugged into a scoring company’s proprietary formula to generate a personal credit score for you. 

Little known fact? You don’t have just one credit score!

You can actually have hundreds of credit scores, depending on where you get your score from and which formula is used to calculate it. Each scoring model has its own rules and weighs each aspect of your report a little differently; the score you get from each of the credit bureaus may differ from the popular models (like your FICO credit score or VantageScore), which will be different from the unofficial scores you may receive from your credit card company or bank each month.

Here’s just one example of a score breakdown, but just know that each and every company has their own unique formula:

Because of this, it may be difficult to gauge exactly what counts as a “good” credit score. For instance, a good credit score is anything 670 and above when looking at a FICO score, while a FICO score of 579 or below is considered poor.

With a VantageScore, though, good credit is defined as everything above 660, but poor is everything under 601.

Plus, you don’t really know which credit score your potential lender will pull… so while you may believe that you have a good credit score, your lender could actually categorize you as having poor credit depending on which model and bureau report they use.

Why a good credit score is so important

So, why does your credit score matter so much? Well, lenders and creditors will use your credit data to help them make a final decision before approving your credit or loan application, and also in deciding the terms you’ll be offered.

Higher likelihood of approval

Whether you’re looking to buy a home, take out a student loan, or open a new credit card, credit checks will likely be included.

Most banking institutions have credit thresholds; if you don’t have a good enough credit score, you won’t be approved. 

Better interest rates

Nearly all credit cards, loans, and revolving credit accounts have one thing in common: you’ll be given an interest rate as part of your initial loan terms. This rate determines how much your line of credit (or loan) will “cost” you in the end, either in the form of amortized interest or finance charges.

Generally, the lower your credit score, the higher your interest rate. Applicants with good credit scores may be able to snag low (or no) interest offers while folks with bad credit may find interest rates well into the teens (or sometimes higher). 

Your credit will not affect your purchase price in any way. However, your overall transaction price may be higher when buying a home, a car, or paying with a credit card if your credit score doesn’t qualify you for a lower interest rate. 

Plus, the higher your interest rate, the longer it’ll take you to pay off your balance, which is money you could instead be putting into an emergency fund or savings account.

More lucrative products and offers

Whether you’re considering refinancing student loans or just looking for an exciting bonus opportunity on a new credit card, the most beneficial products and offers are available to those with the best credit scores. 

Premium credit cards, for example, usually have the best bonus offers and benefits… but they aren’t available to consumers with bad credit scores. And if you’re wanting to shift an installment loan balance with a high interest rate into a loan with a lower interest rate — by refinancing your car loan, for example — you probably won’t be approved without a good credit score.

If you want the best benefits and credit offers, you need a healthy credit score. 

Lower premiums

You may be surprised to learn that even insurance companies will often consider credit scores when you’re applying for new coverage. 

Now, you won’t be rejected by an insurance company for having poor credit alone; however, a bad credit score or negative payment history can impact how much you’ll pay for your coverage. Things like late payments, high credit card balances, or accounts that have gone to collections may indicate irresponsible habits. 

Irresponsible financial habits could potentially translate to irresponsible drivers or homeowners. Because of this, you may be quoted higher insurance premiums if you have a bad credit score or a poor credit history.

Lower (or no) security deposit

Security deposits are common when opening new utility service accounts, applying for certain housing, or in some cases, even renting a car. However, if you have a high enough credit score, you may find that your security deposit can be lowered or even waived.

If you want to avoid locking your money away for months (or years) in a security deposit, a good credit score can help.

Additionally, if you have a lower credit score but want to open a credit card to start building your history, you may be forced to apply for secured credit cards. These credit cards are only offered by certain banking institutions, and require a security deposit of sorts (which also becomes your spending limit). 

Bottom line

Credit checks are a common part of life. They’re especially important, though, if you ever plan to take out mortgage or car loans, open credit card accounts, use student loans to pay for a degree, or even use certain banking accounts to earn higher interest on your money.

Having a good credit score can open many doors. It can result in lower interest rates, greater chances of application approval, and an overall better financial experience. With a very good credit score, you even have the opportunity to earn more interest on your savings balances, take advantage of certain products and offers, or pay off installment loans for less money.

Building good credit takes time and effort, however. By monitoring your credit often, making payments on time (every time!), and paying down your balance as quickly as possible, you’ll be well on your way to a good credit score in no time.