Wondering how to build credit from scratch? Worried you haven't started building credit yet? Here is what you need to know to build good credit for the first time.
There is no other way to say it: Good credit is massively important.
An excellent credit history shows potential lenders that you’re likely to repay loans in full and on time, which can help you lock in better rates on mortgages and other financial products. Even more, the advantages of strong credit go far beyond receiving good rates on loans.
It's weird to say but there is no standard definition for “good” credit. FICO, Experian, TransUnion and Equifax do not tell lenders how to interpret their reports; they just report them.
But “good” credit is often defined by creditors as a FICO score between 680 and 739. At 720, the median FICO score in the US is in the “good” range. This means half of consumers have higher scores and half have lower scores.
FICO scores of 740 and up are generally considered “excellent.”
As a mortgage consumer with good credit, you can get to the next tier — sometimes easily — and lower your borrowing costs.
According to the National Association of Realtors (NAR), about 25 percent of the population has “excellent credit.” These lucky consumers who possess high FICO scores have many more financing opportunities available, and they pay less for them.
Here is how much you might save by increasing your credit score from good to great.
According to data from FICO, an applicant as of this writing with a good 680 score qualifies for an APR of 3.71 percent for a 30-year fixed-rate mortgage. For a $300,000 loan, that’s a monthly payment of $1,316.
An applicant with an excellent 760 score pays just 3.31 percent, saving $67 per month and over $24,000 over the life of the loan.
In addition, those with better credit scores may be able to finance with lower down payments. If mortgage insurance is needed, applicants with higher scores also get lower insurance rates.
The gap between auto financing rates for consumers with good credit and those with excellent credit is huge.
According to MyFICO, auto buyers with 60-month loans pay 6.77 percent if they have good credit, and less than half that — 3.33 percent — when they have excellent credit.
Getting into the excellent range could save you nearly $3,000 over five years.
Your credit score has a greater effect on the interest rate for credit cards because credit cards are unsecured debt. That means the only security the lender has is your promise to repay the loan, and the strength of that promise is reflected in your credit score.
What is a good credit score for credit cards, and how much does it cost you? At the low end of “good,” 680, you’re looking at a 15 percent interest rate on average. At the higher end of the “good” range, that drops to ten percent.
But making the jump to an “excellent” 740 drops your rate to just 7.3 percent.
Personal loans are also unsecured, so your credit rating is the biggest driver of your interest rate.
Rates for a three-year personal loan on peer-to-peer sites and online lenders range between 11 and 15 percent for people with good credit. That’s a $655 to $684 monthly payment for a $20,000 three-year loan.
Borrowers with excellent credit pay between six and ten percent, a monthly payment of $608 to $645. Over three years, that’s a savings of $360 to over $2,700.
It takes time and effort, but perhaps less than you think. You’ll want to stick to your plan and monitor your credit.
Seeing your score increase can be highly motivating.
If you want excellent credit, you must absolutely avoid late payments — a single 30-day late mortgage payment does a lot more damage to a good or excellent score than it does a fair one.
Here are the characteristics of so-called “high achievers,” according to FICO:
No missed payments: 96 percent have no missed payments on their credit report. Data show that it takes about four years following a missed payment for the scores to come back into the highest range.
Long-standing credit: Consumers with excellent credit tend to have a well-established credit history, and they rarely open new accounts. The highest achievers tend to have credit accounts that are at least 11 years old.
They use credit: High scorers not necessarily debt-free. They carry an average of seven credit cards, four with balances. One-third of “high achievers” owes more than $8,500 on revolving accounts.
They weren’t always perfect: About one percent of them have a collection listed on their credit report. And one in 9,000 has experienced tax liens or bankruptcy.
This doesn’t mean that 99 percent have never had a collection, or that only one in 9,000 has severe derogatory events. It just means these things dropped off their credit history before they became high achievers.
Almost as important as your credit history is your “credit utilization” ratio. That’s the relationship between the amount of credit you have available to you and the amount that you use.
Consumers with good credit scores use no more than 30 percent of their available credit. However, those in the “excellent” bunch use much less — closer to ten percent.
Can you reduce this ratio by opening up more accounts? Of course you can — but then, you reduce the average age of accounts and add to the number of inquiries, which may drop your score, at least temporarily.
If you only have one or two cards, however, adding another can help. FICO’s research showed that consumers who max out a single card (easy to do in an emergency or on vacation) are more likely to miss future payments.
Asking your current creditors to increase your credit limit is usually more effective for dropping your utilization.
To obtain the highest credit score, don’t apply too often for credit.
A single inquiry typically causes a five-point drop in your credit score. While FICO won’t penalize you for rate shopping an auto loan or mortgage, too many inquiries for other kinds of borrowing can really hurt.
That’s because FICO research shows that people with six or more inquiries on their credit reports can be up to eight times more likely to declare bankruptcy than those with no inquiries on their reports.
If you have good credit and apply for credit cards geared to those with excellent credit, you’ll be turned down and take a hit for the inquiries as well.
Once you achieve an excellent rating, however, you will get all the love you could possibly want from credit card companies, mortgage lenders and others.
Today’s mortgage rates for borrowers with good and excellent credit are still very, very low. Contact mortgage professionals and see where you stand and how much you can save by raising your score.