Make Friends with your Finances | Volume 15

Have you ever wondered if your credit score important? Well, the answer certainly depends on where you are in life. Do you have so much money that you don’t ever have to borrow? Will you go through life without ever renting an apartment, leasing a car, or getting a cell phone plan? If your answer to those questions is YES, then your credit score is likely of no importance to you.

I’m happy for you, but if you are like me and need to borrow sometimes, your credit score may mean the difference between approval or denial, and that is important.

Your credit history is the foundation of your credit score. The credit bureaus compile information about your borrowing habits to calculate a score that can be used by potential lenders to determine if you are a good risk or not. The higher the score, the lower the risk and the greater the likelihood that you will be approved for a loan with a better interest rate and/or terms.

While each credit bureau may weigh factors differently, the following key elements generally influence your credit score:

1. • Payment History
     Are you making your payments on time? A consistent record of on-time payments builds trust with lenders.

   • Amounts Owed
     What are your current balances? High balances can indicate risk, even if you’re making payments.

   • Length of Credit History
     Are you well established or just starting out on your credit journey? A longer history can have a positive impact.

   • New Credit
     Have you applied for credit recently? Multiple recent inquiries may be seen as a red flag.

   • Credit Mix
     Do you have a variety of credit types—such as secured loans (like an auto loan) and unsecured debt (like credit cards)? A healthy mix can boost your score.

   • Credit Utilization Ratio
     How much do you owe compared to your credit limits? Are your cards maxed out, or are your balances low? Lower utilization is generally better.

   • Negative Marks
     Have you caused a loss to a creditor, such as through bankruptcy, charge-offs, or having accounts in collections? These can significantly impact your score.

Once all of this information is gathered, a credit score is calculated, typically ranging from 300 to 850, with 300 being the lowest and 850 the highest possible score. While the exact formula is proprietary and not publicly disclosed, it is widely understood that the two most influential factors are Payment History and Credit Utilization Ratio.

The best advice I can give is to pay your bills on time and keep your balances low. Most recommend that you keep your balances below 30% of your credit limits. I recently heard that 23.4% is the magic number, but my experience has been that keeping as low as possible, well below that 30%, helps to keep my credit score up.

Why is this important? Lenders use more than just your credit score to determine if you will be approved for a loan, but many use the credit score to determine what interest rate and/or terms you will be approved for. The lower the score, the higher the interest rate, which means you will end up paying more over time than if your score was higher. It can make a big difference in your monthly payment and how much you will eventually pay by the time your loan is paid in full.

Here’s an example to put it into perspective: Let’s say you’re financing a $50,000 car with a 5% interest rate over 60 months. Your monthly payment would be around $950, and you’d pay about $6,600 in interest over the life of the loan, for a total cost of approximately $56,600.

Now, if that same loan came with a 6% interest rate instead, your monthly payment would rise to about $967, and you’d pay more than $8,000 in interest. That extra $17 per month might not seem like a big deal at first, but it adds up to a difference of over $1,400 by the time the loan is paid off.

And if your credit is in rough shape, you may not even qualify for rates that low. At 10% interest, the monthly payment jumps to about $1,063, with nearly $14,000 paid in interest over five years. That’s a significant cost difference—money that could’ve stayed in your pocket with a better credit score.

Sorry for all the math, but these are things I wish I had a better understanding of 30 years ago when I got my first loan. I’m pretty sure I just sat there, they told me what my monthly payment would be, and I said, “Sure, I can afford that,” without really knowing what I was signing up for or how much it would cost me in the end.

Did they explain it to me? Probably. Was I paying attention? Probably. Did I really understand? No. I’m certain I didn’t. I never thought to check if the interest rate was competitive, and I definitely didn’t shop around. I just needed a car and was thrilled to drive off the lot in that shiny new ride. It was a cute little car, and it was mine—or rather the bank’s—until it was paid off, anyway.

There’s no bad ending to this story, thankfully. The interest rate was decent for that time, and the car was eventually paid in full. But cars weren’t nearly as expensive 30 years ago. Today, we’re looking at car prices that rival the cost of a house back then. That’s why understanding interest rates is more important than ever when making a major purchase, and having a good credit score can make all the difference in getting a favorable one.

If you’d like help becoming friends with your finances, please reach out to me by sending an email to kvaillancourt@acadiafcu.org or by calling 207-992-1060. Financial counseling services are free to members of Acadia Federal Credit Union.