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When you're applying for a new loan or other credit, your credit scores determine more than the likelihood you'll be approved—they also play a big role in determining what interest rate you'll be offered.
People with higher credit scores tend to consistently pay back debts on time as agreed, so they typically get the lowest interest rates. Their proven history with credit is more desired by lenders, who are always looking to minimize risk.
What Is Creditworthiness?
Creditworthiness is just what it sounds like—it's how a lender evaluates your credit and decides whether you're eligible for, or worthy of, a new account. When a lender reviews your credit report, they'll look at your repayment track record and other aspects of your borrowing history to get a sense of how likely you are to repay a loan.
These items, plus your credit score, help lenders decide whether they feel comfortable letting you borrow money, and if so, what rate they will offer. A poor credit score won't necessarily disqualify a borrower from taking on credit, but it's likely to cause a lender to charge a higher interest rate to offset some of its risk.
How Your Credit Score Determines Your Interest Rates
Your credit score and credit report give lenders a window into your past behavior, but they're also viewed as a predictor of your future behavior.
If someone has excellent credit, it's likely because they've made responsible financial decisions such as repaying bills on time, keeping debt low and having accounts in good standing over a long period of time. Because lenders can be more confident someone with a higher credit score will repay the debt in full and on time, they usually charge these borrowers a lower interest rate.
When a lender is sure it'll get its money back, it doesn't feel the need to guarantee returns with a high interest rate. When you're applying for a mortgage, a high credit score may also help you qualify for a lower down payment. Again, because you're lower risk in the lender's eyes, it may decide you don't need to provide as much upfront to guarantee the loan.
When someone has less-than-stellar credit, it might be due to missed or late payments, high amounts of debt, or negative marks such as bankruptcy or accounts in collections. A lower score and negative items on a credit report make a borrower appear riskier to a lender. If someone has struggled to pay debts on time or at all, the lender will have concerns that this person might not be able to repay the debt they're applying for.
A low credit score could also mean someone is brand new to credit and hasn't yet established a positive payment track record. A borrower who doesn't have much of a credit history is more of an unknown and, without a track record that proves their ability to repay, a lender likely won't be as comfortable extending them credit. If a lender does decide to approve someone with lower credit scores, they will often give them a higher interest rate to mitigate risk.
How to Improve Your Score to Get Better Rates
Having a good credit score is valuable for numerous reasons, and not just for scoring the lowest interest rates. If you want the best chances of getting approved for loans or credit cards at the lowest interest rates, it's time to get cracking on improving your credit score.
Here are a few ways to improve your credit score before you apply for new forms of credit:
- Keep your credit card balances low. Your credit utilization ratio tells lenders how much of your available credit you're using at any given time. Using more than 30% of your credit limit is risky in the eyes of lenders and may lower your credit scores, so try to make sure your credit card balances stay well below your credit limit.
- Make on-time bill payments. Late or missed payments can really ding your credit score, so pay every bill on time. This includes credit cards, loans and utilities. Set up calendar reminders or autopay if you have trouble remembering when bills are due.
- Don't close accounts unncessarily. Open credit card accounts contribute to your credit limit and may help keep your utilization rate low, so try to keep them open. If it's a credit card you rarely use, just set up a calendar reminder to use it a few times a year to keep it active. If you don't want to pay the annual fee on an unused credit card, consider asking the card issuer to keep your account open but "downgrade" the card to one with no annual fee.
- Check your credit report. Review your credit report periodically to spot potential fraud, review trouble areas such as high debt and dispute any potential inaccuracies. Checking your own credit report won't lower it, so feel free to check it as often as you like. You can check your credit report for free through Experian or at AnnualCreditReport.com.
Another Way to Increase Your Credit Score
While all forms of credit and debt are shown on your credit report, your utilities aren't on there by default. Now with Experian Boost®ø, your on-time payments such as your cellphone bill and other utility bills don't go to waste—you can opt to have them show up on your credit file and help improve your score.