Video: How Your Credit Score Affects Your Loan Payments

TRANSCRIPT

Hi, my name is Emily Phelps. I’m a certified financial counselor. I’m really excited to talk to you today about some credit tips.

So why should you care about your credit score when applying for a loan? If you have a high credit score, you’re more likely to get approved for a loan and have a lower interest rate. Right now, interest rates on auto loans are, if you have a really great credit score, starting at about five percent. A low credit score, you could be looking at like eleven to fifteen percent on an auto loan depending on the term you’re looking at, the amount you’re looking to borrow, all those sorts of things. You could be looking at paying $300 a month. Just that increased interest cost, you could be looking at $350 to $400 a month in that monthly payment.

There are three credit reporting agencies out there. TransUnion, Equifax, and Experian. You’ve probably heard of them before. All of them gather all your credit data together. So they’re gathering your loan payments and all the different loans that you have. Usually, just loan payments. It’s not your checking account information, not your bank information, usually not utility information, just your loan repayment history. So they gather all that information together, and then lenders choose to work with one or all of those companies to get a credit report from you when you’re applying for a loan. Usually, what they’re pulling is a credit report from one of the three agencies and a FICO score for you, which is that score in that 300 to 850 score range.

All three companies are slightly different, and it really depends on what FICO model they’re using to score your credit. That’s where if you go to one place, you’ll get one credit score. If you go to a different lender, you’re going to get a slightly different credit score.

But what lenders do to kind of determine how they’re going to use your credit is they use this thing called risk-based pricing, where they say, “Okay, if your credit score is between this tier and this tier, you’re going to get this interest rate. If between this one and this one, you get this interest rate.” So that’s where somewhere you might have a 700 credit score and somewhere else you might have a 730 credit score, but you might get the same interest rate at those two lenders no matter what your actual score is. And that’s how banks kind of determine, using your credit score, what your interest rate on loans is going to be.

 

So what do banks get when they pull your credit? Well, it kind of does depend on the type of loan it is and what they’re pulling the credit for. Most consumer loans they’re only pulling one of the three credit reports for you. That is kind of why you want to make sure all three agencies, Transunion, Equifax, and Experian, are all looking good and all looking the same because you may not know in advance what specifically that lender is using in terms of your credit score and your credit report.

So how do you know what a good credit score is? Usually, a really good credit score is anything between 700 to 850 in the credit score range. Anything 700 to 730 and above is going to be an excellent credit score. If you’re within the 600, you have an average credit score. If you’re about in the 500s or below, that is a low credit score. What that really means in terms of your credit report is people with a higher credit score have a lot of payment history. They have a lot of history underneath their name of past loan repayment. So if you do not have a high credit score, it usually means that there was some negative information in the past on your credit report or you just don’t have a lot of payment history. A lot of credit issues are based on building loan payment histories on time, over time.

As a lot of people say, you have to have credit to build credit. So, to really start building credit, you’re going to need to open a loan and have some sort of payment history reporting to your credit report. It doesn’t have to be a big loan; it just has to be an on-time payment history over time. Really credit is less about how much money you’re taking out and more about that on-time payment history. So getting a small personal loan, a small secured credit card, something to try to just help you out and get started. Credit just takes time to get better at. And as long as you’re doing your monthly steps of making your loan payments, making your payments on time, and keeping your debt low, you are going to get credit over time.

If you have issues on your credit report, if there have been negative items in the past that are causing you to have a low credit score, you may want to be looking at ways to increase your credit score and to help you out down the road, decrease the interest cost on future loan applications you may have.

So, to get a full copy of your credit report, go to the credit bureaus. There are many places online where you can get a free credit report and see what’s reporting on there. If you have any net past negative open collections or late loan payments on your credit report, it is worth your while to look at clearing those up either by paying off past collections, by disputing mistakes on your credit report, or sometimes by just matter of age of building up a new good on-time payment history to push back old mistakes, old late payments, in the past on your credit report.

Say you don’t have great credit, but you are approved for a loan right now. That doesn’t mean you still don’t want to keep working on your credit score to save you money in the long run on future interest.

The rates banks and credit unions give you aren’t personal, unfortunately. It really is based on your credit information on paper. You may have a lot of other great things working for you. You might have a great job time, high income, and great stability in your life, but if you don’t have the credit to match up to it, it’s an on-paper decision, unfortunately, that banks and credit unions have to make to lend to you at a higher rate. So really working on your credit, in the long run, means that all those other things that are working for you, you’ve got your credit working for you as well. That means you are going to be paying less in the long run.