Your Credit Score Dictates Your Personal Loan Odds and Your Interest Rate – Here’s How
It’s hardly a secret that personal loan providers rely heavily on credit scores to weight loan approvals. The fact is, lenders do just that.
What may be surprising is how much lenders and credits lean on credit scores and what credit score components they use most before making lending decisions.
Typically, lenders review credit scores along with other personal finance factors like income, whether the borrower has a job or not, and any bankruptcy or loan payment abandonment issues. But when it comes to making an actual decision on approving a loan or not, it’s the credit score that rules the roost.
“Credit scores do affect consumer loans,” said Ann Martin, director of operations of Credit Donkey, a personal finance product and service reviews platform. “Most private lenders have a minimum credit score requirement in order to access loans.”
According to Martin, the minimum credit scores for accessing personal loans usually fall into the range of 650-750 FICO scoring range (the FICO model uses a 300-to-800 credit scoring range formula. “Of course, the higher the better,” she said. “I usually recommend aiming for 700 when applying for a personal loan.”
In dollar terms, a borrower’s credit score can have a significant impact on household finances in general, and loan and credit outcomes in particular. Data also shows the better your credit score, the more money you can borrow in a personal, if needed.
In comparison, the lower your credit score the more you’ll pay for a personal loan – if you can even qualify for one.
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According to Washington, D.C.-based FINRA Investor Education Foundation (FINRA), a low consumer credit score could result in a big reduction in cash on hand every month. This from FINRA:
Suppose you want to borrow $200,000 in the form of a fixed rate thirty-year mortgage. If your credit score is in the highest category, 760-850, a lender might charge you 3.307 percent interest for the loan1 This means a monthly payment of $877. If, however, your credit score is in a lower range, 620-639 for example, lenders might charge you 4.869 percent that would result in a $1,061 monthly payment. Although quite respectable, the lower credit score would cost you $184 a month more for your mortgage. Over the life of the loan, you would be paying $66,343 more than if you had the best credit score. Think about what you could do with that extra $184 per month.
Boosting Your Credit Score – and Saving Money in the Process
The good news is that consumers can improve their credit scores and place themselves in a more optimal position when applying for loans and credit. Take these steps to turbo-boost your credit score.
Know your goal. While credit scores aren’t an exact science, lenders do look for credit scores in a certain range.
“In general, the best interest rates are offered to borrowers with scores of 740-760 or higher, so that provides some context for borrowers,” said Joseph Toms, president and CEO of Freedom Financial Asset Management in San Mateo, Cal. “In terms of credit scores overall, “very good” is 740-799, and exceptional 800-850.”
Create a step-by-step credit improvement campaign. Your next action step? Lay out a blueprint for improving your credit score. Start with these money moves, advises Castleigh Johnson, a former banking executive and founder of My Home Pathway, a mortgage loan services company.
- Pull at least one of your credit scores. You can get a full report from AnnualCreditReport.com, the free annual credit report site. Note there are three credit bureaus: Experian, Transunion and Equifax. Each has a credit report in your name, assuming you already have a credit history.
- Take a deeper look. Review the report to ensure all the information in there is accurate, many reports have errors on them. ‘If there’s information on there that is inaccurate file an online dispute,” Johnson said. Each credit reporting bureau has a web page devoted to filing an inline dispute.
- Learn how credit scores work. Pay particular attention to payment history and credit utilization. Those two categories comprise up to 65% of your total credit score. “Keep payment history (i.e., on time payments) at 100% and utilization (how much credit you’re using) under 30%.”
- Focus on behavior. Create a plan to improve your financial behavior and financial profile and stick to it. “Then, assess, adjust and keep working on the plan as your credit improves,” Johnson added.
Pay down debt. There’s a pattern to spending and debt that reflects directly on a consumer’s credit score.
“Minimizing credit utilization, for instance, will lower the amount of debt you have, thereby improving your debt-to-income ratio,” Tom said. “Less outstanding debt usually will improve credit scores.”
If you’re able to pay debt down on your own with the avalanche (paying larger debts first) or the debt snowball method (paying smaller debts first), do so.
“If not, and you are carrying credit card debt, a balance transfer can be helpful, as it transfers the balance to a low-interest, or zero-interest credit card,” Tom said. “For someone who’s suffered a financial hardship, and is having a hard time with even minimum payments, debt settlement may help.”
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The Takeaway on Credit Scores and Personal Loans
Personal loan borrowers should know that credit scores are a critical component in gaining a loan approval – and that’s for good reason.
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“Credit scores are the entry gates to most financial products that consumers acquire from auto loans, credit cards, mortgages and personal loans,” Johnson said. “They can be a filtering tool to help lenders find the consumers they want to do business with and then how much they should charge the consumer for that product.”
The upshot? By improving your credit score, you’re also improving your odds of landing that personal loan.
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Brian O'Connell has been a finance writer at TheStreet, TheBalance, LendingTree, CBS, CNBC, WSJ, US News and others, where he shares his expertise in personal finance, credit and debt. A published author and former trader, his byline has appeared in dozens of top-tier national publications.