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Personal Finance

How Good Credit Can Save You Money

Having a high credit score has a lot of benefits, but the most important one is that it can save you money.

A strong credit history can help you leverage your credit score to save hundreds or even thousands of dollars when you take out a loan, get more value out of credit cards and help you qualify for better insurance rates.

Here are three key ways you can use your credit score to improve your financial health.

Qualify for Better Interest Rates

When you apply for a credit card or loan, lenders typically use what's called risk-based pricing to determine whether to approve your application and what interest rate to charge.

If your credit score is high, data shows that you're less likely to default on the new account than someone with a low credit score. As a result, you can usually expect to score a lower interest rate, which will save you money over the life of the loan.

For example, let's say you apply for a $30,000 auto loan and want to pay it off over five years. If you have excellent credit, you may qualify for a 3.5% annual percentage rate (APR), which will give you a monthly payment of $546. In this case, you'd pay $2,745 in interest over five years.

However, if you have fair credit, you may qualify for a pricier 8% APR. This would increase your monthly payment to $608, and you'd end up paying $6,498 in interest over the life of the loan. In this scenario, having great credit would save you $3,753.

Of course, lenders consider more than just your credit score. They may also look at your debt-to-income ratio—how much of your gross monthly income goes toward debt payments—as well as specific items on your credit reports, such as recent inquiries, delinquent payments and more.

However, your credit score provides a quick snapshot of your overall credit health, and having a good credit score can make it easier for you to qualify for better interest rates on both loans and credit cards. And if you've improved your credit score since you were approved for a loan, you may also be able to refinance it with a new loan at a lower interest rate.

Get the Most out of Your Rewards Credit Cards

A lot of credit cards provide rewards in the form of introductory offers and points, miles or cash back every time you use them. The best rewards credit cards are typically designed for people with good or excellent credit, which generally means a FICO® Score of 670 or higher.

With the right credit card in your wallet, you can earn cash back (which is effectively a cash discount on every purchase you make) or points or miles that you can use to book travel, buy gift cards and more.

Some travel rewards credit cards provide introductory offers that are worth hundreds of dollars in free travel, which can help you plan a vacation for much less than it would normally cost.

One thing to keep in mind, though, is that credit cards charge interest if you carry a balance from month to month. And while having stellar credit can help you qualify for a lower interest rate, the Federal Reserve currently puts the average credit card interest rate at roughly 17%, which is still higher than other forms of debt.

As such, to maximize the value you gain from credit card rewards, it's important to make it a goal to pay off your balance in full each month to avoid interest charges.

Look Into a New Insurance Plan

Another way your credit score can impact you is through your car insurance and homeowners insurance policies. In most states, insurance companies are allowed to use your credit report information to create a credit-based insurance score.

This is because data shows that people with higher credit scores are less likely to file insurance claims, and therefore, cost the insurers less money. In turn, insurers are more likely to give you a lower rate because you pose less of a risk.

The only states that don't allow insurers to use credit information to determine rates include California, Hawaii and Massachusetts.

One thing to keep in mind is that insurers aren't allowed by law to hike premiums solely because you have a low credit score—there must be other reasons present. But having a higher credit score could ensure savings.

Build Your Credit to Take Advantage of Savings

If you already have an excellent credit score, continue to practice good credit habits to maintain that score. But if your credit history needs some work, the time and effort you put into improving your credit will pay off in long-term savings.

Start by checking your FICO® Score and credit report to see where you stand. Pinpoint areas that need to be addressed and focus on them first.

For example, if you're behind on payments with one or more accounts, get current quickly and continue to pay on time every month. If you have high credit card balances, focus your efforts on paying them down to lower your credit utilization ratio. And if you notice any items on your credit reports that you believe are inaccurate or potentially fraudulent, take steps to dispute the information with the credit reporting agencies. Other tips include:

  • Ask a family member with great credit to add you as an authorized user on their credit card account.
  • Avoid applying for credit unless you absolutely need it.
  • Consider using a credit-builder loan or secured credit card to establish a positive payment history with a new account.

As you take these and other steps to improve your credit, you'll start to be able to take advantage of the savings that come with a better credit score.