When you maintain a good financial reputation, you reduce the perceived risk associated with lending to you, which can help increase your chances of qualifying for a loan at a reasonable interest rate. It is not just lenders who reference your credit score to make a decision—a good credit report may impact whether an employer will hire you, which landlords will rent to you, and the associated risk you present for insurers.
A good reputation is not built in a day but can have a great impact on what can be built tomorrow.
Because we often set budgets based on monthly payment obligations, the difference between good and bad credit may seem nonexistent. However, when you consider the long-term effects of a loan and the associated interest rate, it can dramatically impact your finances – both positively and negatively. According to Experian, in the 3rd Quarter of 2021 the average loan rate for a new car for someone with a prime credit score (661 to 780) was 3.84%, and in the near prime category (600-660), it was 6.32%. By using Arvest’s Loan Calculator, for the same $30,000 loan over a 72-month period, the person with a lower credit score will end up with a loan payment that is $34.56 more each month. It may not seem like much, but it totals an additional $2,488.32 over the course of the loan.
Although the difference in interest rate based on credit score will usually be much smaller for a mortgage, the borrower is paying for a larger amount of capital for a longer period, so the total interest paid is significantly larger. By using Arvest’s Fixed Mortgage Calculator, we can enter a hypothetical example of someone with excellent credit who receives a 3% rate for a $350,000 mortgage vs. someone who receives a 4% rate. The 1% difference increases the monthly cost by $195.34, or $70,322.50 over the life of the loan.
The benefits of good credit go far beyond qualifying for better loans. Credit can also affect your rate on homeowner and car insurance. Insurance companies assess borrowers with good credit to be in a lower risk category, and according to research from WalletHub, in many places the difference in premiums for car insurance will be higher than 20% and could even be higher than 50%. High insurance rates are not just based on making extremely poor decisions like getting a DUI. Alternately, for those with great credit, one might estimate insurance cost savings of $47 each month, when estimating the average full coverage car insurance rate to be around $1,800.
Other factors aside, with the same obligations and a difference of good to great credit in this scenario, a person might hold onto an additional $250 each month because of their solid financial reputation.
Taking those savings a step further
Let us say one is saving for retirement and starts investing the additional $250/month in a Roth IRA over 30 years. By using Arvest’s Roth IRA Calculator, we can see with a 7% return they could end up with $303,219.18. The additional funds could create a more comfortable retirement, or even make it possible to retire earlier.
How should I start building my credit score?
We actively build our financial reputation by paying bills on time, borrowing money and paying it off, and establishing collateral or an asset base for leverage. However, even a person who pays all their bills on time may not have the very best credit score.
Various misconceptions about credit scores exist, which could prevent people from addressing them. Knowing the truth about credit scores and the factors that influence them can help you take necessary steps to build a good financial reputation:
Misconception: Checking my credit score will always hurt my credit score
In fact, checking your own credit score does not hurt your credit score, and statistics show people who do are likely to improve their credit scores. However, there is a small negative effect associated with a “Hard check,” which is done by a company on your behalf when you request to extend credit—such as through loans or credit increases. If companies see you have suddenly been asking for credit from numerous sources, it may appear you have not been meeting your financial obligations.
Misconception: I need a credit card to establish a credit history
In fact, the easiest way to establish credit history is typically to get a secured credit card or loan—a loan with a co-signer sharing the liability—and build your way up from there. However, a credit card is not required to establish a credit history. Another tactic is to request your landlord or utility company provide a record of your on-time payments to credit bureaus.
Misconception: Paying interest on credit cards improves my credit rating.
In fact, paying on time can improve your credit score even if the balance is paid down to zero. Although having active accounts for a longer period can increase your creditworthiness, it is not necessary to carry a balance from month to month. Your financial reputation is more about whether you are meeting payment obligations than about the amount of interest you pay to lenders over time.
Misconception: I should only ask for the amount of credit I need.
One of the metrics for determining your credit score is your credit utilization. If you ask for a credit increase, it will further reduce the amount you utilize. For example, if you have one credit card and you are utilizing $5,000 of a $10,000 limit, your utilization would be 50%. If your limit increased to $15,000, your utilization would be reduced to 33%, which could improve your credit rating.
This limit increase would represent a “Hard check” on your credit rating, which may reduce your score at the same time. However, the change will only affect your credit rating for one year and may be less impactful than the good credit you gained from reducing utilization.
Make your financial reputation a priority this year
Because we do not check our credit scores daily, it is easy to put it aside and ignore it. However, it is one of the most important factors when building wealth across decades. If you are interested in building wealth over time and making your financial history support your goals, you can start by speaking with a client advisor, such as those at Arvest Wealth Management.
This content has been prepared by The Merrill Anderson Company and is intended as a general guideline.
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