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When you're shopping for an auto loan, mortgage, credit card or other credit product, lenders may rank your creditworthiness by credit tier. Credit tiers are typically based on your history as a borrower, so they affect how likely you are to get approved for a loan, as well as the terms and interest rate you may secure.
Depending on your credit habits and possibly other factors such as income, you may have tier 1, tier 2, tier 3 or worse credit by a lender's standards. Tier 1 credit is considered the best, and will generally qualify you for the most favorable loan terms. That could translate into savings of hundreds or thousands of dollars over the life of a loan.
What Does Tier 1 Credit Mean?
Lenders designate credit tiers as part of what's called risk-based pricing. Using criteria such as credit score, current debts and income, they employ this method to determine what interest rates and terms they'll offer a particular borrower. Borrowers who are most likely to repay their debt—and thus present the least risk to the lender—are offered the lowest interest rates and best terms. These borrowers fall into the lender's tier 1 credit range.
Borrowers who present more risk to the lender will fall into lower credit tiers and will pay higher interest rates and possibly additional fees on a loan or credit card. When a borrower's application is approved but they receive less-favorable terms due to information on their credit report, the lender is required by law to send them a risk-based pricing notice. The lender provides this notice verbally, electronically or in writing after they've determined the rates and fees on a loan but before the borrower has accepted them. After viewing the notice, the borrower can decide whether to accept the loan under the terms offered.
What Credit Score Do I Need for Tier 1 Credit?
Your credit score is a three-digit number lenders use to help determine your creditworthiness. While most consumers have many credit scores, lenders typically use a version of the FICO® Score* or VantageScore® when determining how likely a borrower is to repay debt. These scores range from 300 to 850, with higher numbers meaning better credit.
So what credit score do you need to attain that coveted tier 1 status? There's no single answer. Each lender uses its own calculations and level of risk tolerance to decide which borrowers get the best rates. So while you may be a tier 1 borrower with one lender, you may have tier 2 or tier 3 status with another.
In FICO's scoring model, scores in the 800 to 850 range are considered exceptional, or best. A given lender, however, may consider scores in the 750 to 850 range as best and categorize those borrowers as tier 1. Another lender might have a completely different range it considers tier 1.
While it may be a slight mystery where you fall on a certain lender's tier scale, working to improve your credit will give you the most chance of reaching tier 1 status.
How to Get Tier 1 Credit
There are plenty of actions you can take to improve your credit score and work toward achieving excellent credit. Here's how:
Pay Your Bills on Time
Get into the habit of paying every bill on time. Payment history is the biggest factor in calculating your credit scores, and thus your credit tier, so make this a top priority. Even one late payment on your mortgage, credit card or other bill can lower your credit score, so on-time payments are essential.
Pay Down Debt
Paying down debt is easier said than done, but carrying large balances on your credit cards raises your credit utilization ratio—the amount of debt you have relative to your total available credit. Most lenders prefer a utilization ratio of 30% or less, but the lower the better.
What can you do to pay off debt? Reducing your debt load can be a long process, but your first step should be to review your existing accounts so you know exactly what you owe. Next, create a budget that allows you to put as much money as possible toward paying down your debts.
Apply For and Open New Credit Accounts Only As Needed
While it may be tempting to open new credit accounts to make major purchases or to take advantage of promotional credit card offers, frequently applying for credit can take a toll on your credit score. Carefully consider whether a new account is justified, as credit applications require a lender to pull your credit report, resulting in a hard inquiry. Too many hard inquiries on your credit report will lower your credit score.
Dispute Any Inaccuracies on Your Credit Reports
Check your credit reports with the three major credit bureaus (Experian, TransUnion and Equifax) for any information that shouldn't be there. Incorrect information may indicate fraud or identity theft. Make sure that all of the accounts listed on your reports are correct and dispute any inaccuracies to get them resolved as soon as possible.
Achieving Tier 1 Credit Is Possible
If you don't have tier 1 credit but wish you did, know that hard work and persistence can get you there. Since tier 1 credit can qualify you for the best rates and terms on auto loans, achieving it can save you money down the road, so it's a worthwhile goal.