I was sitting in a bar one night with an accountant friend "talking shop". We discussed everything from student loans to credit scores to the poor spending habits of our fellow millennials. She described a credit score in such an understandable way. Your credit score is your word to a lender to pay the money back.
If you lend a friend $20 once and they don’t pay it back, how likely are you to lend that same friend more money? Depending on the circumstances, probably not likely. This is the same with lenders. If they see that you haven’t done a good job of paying back other lenders, they are more wary of letting you borrow money from them.
So when you apply for any type of loan, the lender will pull your credit report to see your credit score. This essentially is your grade. Personal finance is a class and you're being graded as a borrower.
This number can range from 300 to 850, or 0. It's sort of like the SAT where if you've made a solid attempt, you get some pity points. A score of 300 is still not great, but it’s a million times better than 0. If you’re a recent post-grad and your credit score is above 750, you should probably be writing these articles instead of me.
So let’s say you have never applied for a credit card, don’t have any student loans (lucky bitch), and your car didn’t require payments. You have no credit. You’ve never borrowed money, so you don’t have a score on how you’ve paid it back. Stay tuned, this is easily fixable.
Most students have some sort of credit. Maybe the electric bill is in your name and you’ve paid it religiously on time. Or you could have a store credit card that you pull out and put your 7 for $27 panties on every time you get the VS text alert. As long as you pay these off in full, you are on the right track towards building a credit score.
Back to the lender. They pull your credit report and see your score. Now what? They use this score to determine the interest rate for the money you just decided to borrow. The higher your credit score, the lower your interest rate. And visa versa.
Let’s use a car loan for an example. You need a $10,000 loan and the rates range between 3% and 15%. If your credit score is closer to 300, your interest rate will be in the 15% range. Whereas if your credit score is around 700, your credit score is more likely to be in the 3% range.
Why does this matter?
Say your loan is 36 months. Your $10k loan at 4% will be $295 per month. However, that same loan at 12% will be $332. This is only a $37 per month difference. That’s maybe a meal out and one coffee, no big deal. But over 36 months? You pay $1,332 more just for having a lower credit score.
So just because you have been loyal to paying back all the other money you have owed, you don’t waste as much money on interest each time you need to borrow money. It doesn’t cost you any extra to pay all of your bills on time each month, it’s just part of adulthood. You will need to borrow money eventually whether it be for a car, house, or maybe even refinancing your student loans. Save yourself the money and stress and start caring about your credit score now.
Moral of the story? Pay your credit cards off. In full. Every month. This will help you build and maintain credit so your interest rates will be lower in the future.