The benefit of having a good credit score is not about the chances of getting a loan as with bad credit you still can get a loan. But most importantly, the better the score the lower is the interest charged on the loan.
According to myfico.com, the difference in interest charges between a person who has a score of 500 and other with a 720 score is 4.54 percentage points.
This means, on a $ 100,000, 30-year mortgage, you could pay an extra $117,152 in interest charges. Or, in monthly payment, the difference would be $326. Remember, this potential saving is only for one loan.
What is Credit Score?
Credit score is a 3-digit number generated by a formula based on information of a person’s credit report. In this scoring system, the number predicts how likely the person is paying his or her bills when they due — his or her creditworthiness.
Credit rating is fairer than judgmental methods because it’s based on real and empirical data of millions applicants.
This objectivity supports the Equal Credit Opportunity Act (ECOA). That law doesn’t allow lenders to predict a borrower’s risks based on factors, such as race, sex, marital status, national origin, or religion.
FICO Credit Scoring Systems
Fair Isaac Corporation was the first company that developed a credit scoring system. The scoring company created a system of assigning value to your credit standing.
The score was named the FICO score. It has scoring scale ranges from 300 to 850, where about 85 percent of people in the U.S. have scores between 600 and 800.
Today the FICO credit score is the most widely used credit scoring system and becomes the standard score used by the three major credit bureaus — Equifax, Experian and TransUnion.
Those credit reporting agencies have their own system for calculating credit rating. Even though all the three scores are developed by Fair Isaac Corporation, there are slightly differences at the three credit bureaus.
If your information were same at all the three bureaus, however, your scores from all the three would be within a few points of each other.
How Your FICO Score Affects Interest Charges
When you apply for a loan, your lender would ask to get access to your credit rating from any of the three credit bureaus. The lender then evaluates your credit reports and scores to make loan and interest rate decisions.
The rate you received from the lender will be directly related to your credit rating. The higher your number means the lower interest rate you’ll be charged.
When a lender receives your FICO score from a bureau, up to four score reasons are given. If the lender rejects your loan application, these score reasons can help the lender tell you why your score wasn’t higher.
These reasons are more useful than the score itself in helping you decide whether your credit report might contain errors.
So, understanding your FICO credit score before you get credit is good for fixing credit and saving money from unnecessary interest charges. The above example is a proof that being careless with credit might result in ten thousands of potential loss.
The Best Place to Check Your FICO Credit Score
First, make sure you get your FICO scores and not FAKO or other scores. The reason is most lenders use FICO scores for screening loan applicants. You will want to make sure your FICO scores are good enough for your lender. This is the only way to get a loan with favorable terms.
Next, signup for the free trial membership at myFICO (read my review here). You will need to provide a credit card. Don’t worry, you can cancel your subscription before the trial period is over.
Many people are looking for free credit scores from sites with no trial offer and no credit card. But they are wasting their time and money because those sites don’t offer the real FICO score. The only site that offer true FICO score is myFICO.