How Much Do Credit Scores Really Matter?

Obsessing over a number that’s only three digits long sounds a little OCD, until you realize how much a hundred or so points on it can cost you. I’m referring to credit scores. This three-digit number that lenders use to determine how favorable a loan to give you can affect many of your financial transactions, but it especially becomes a big deal when you take out a mortgage on a house. Let’s look at a home loan for $300,000 with two different sets of scores:

Credit Score 620-659
APR: 7.115%
Monthly payment: $2,019

Credit Score 760-850
APR: 5.799%
Monthly payment: $1,760

The higher better score saves $259 per month, or $93,240 over the course of the loan. So how do you make your score better? Well, improving your score is sort of a universe unto itself but you can get started by first finding out your credit score by reading our post, “Where To Get Your Real Credit Score.” Then, to learn how to improve your credit score, you will want to learn about “reason codes,” as described in our post, “Know Where To Fix Your Credit Score By Getting Your Reason Codes.” After that it will depend on your specific history.

(Photo: KUTV)

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  1. timmus says:

    If lenders are using our FICO scores, we should be entitled to get them for free. Why did this not get tacked onto the FACT Act? Oh that’s right… corporate money making the rounds on Capitol Hill.

  2. SuffolkHouse says:

    Who the hell is getting 5.799% nowadays? I have golden credit, 800+, and I got 6.5%.

  3. Landru says:

    @SuffolkHouse: Noboyd is getting 5.799% – they have to make up the money lost in the crash somehow.

  4. Mollyg says:

    It is my opinion that credit scores are not designed to tell who is more risky to lend to, but rather to determine who would be a better customer. The evidence that I use to support this is that some of the factors that will raise your credit score go against good money management practice.
    One example of this is that it makes good financial sense to avoid debt as much as possible and live within ones means, however this will result in a lower credit score.
    Another example is that it is good financial sense to shop around when looking for a mortgage or credit card, however every time someone looks at your credit score, your score goes down. Some times mortgage companies want to look at a credit score before they give you a firm rate quote.
    I think that a true measure of ones ability to repay loans would look quite different then what is used now.

  5. UpsetPanda says:

    @Mollyg: How does living within one’s means result in a lower credit score? Is it relative to income? If I had a $500K/year income, and I lived within my means, would my credit score be higher than if I made $30K/year and lived within my means? I haven’t gone so far as to buy a house or a car, so I haven’t needed to shop for loans. I figure this is good research for when I finally choose to do these things.

  6. 310Drew says:

    I just took out a loan at 5.75% last month. If your bank/lender charged you more, either it’s because you took out a jumbo loan, or they decided they can make more money off of you and you went for it. I am in the process of closing on a HELOC with National City Bank, and was told my rate would be 7.25%, essentially prime plus a margin of 1.25%. I told them i would go elsewhere, and in a matter of minutes and supposedly talking wtih a manager, the rate dropped to prime minues 1.01%, so now they are offering me 4.99%.

  7. johnva says:

    @Mollyg: Nonsense. The credit score formula has no idea whether you are “living withint your means” and “avoiding debt as much as possible”. It just goes by what is reported in your credit report. The FICO formula cannot differentiate between whether you are paying off your credit card account every month, or carrying a balance. It just knows what percentage of your credit line is in use at the time a snapshot of it is taken and placed on your credit report. They don’t even know what your income is.

    As for the mortgage lender thing, they changed it so that all mortgage inquiries within a short time basically count as a single inquiry in the formula (which doesn’t hurt you much if you didn’t have other very recent inquiries). So you lose nothing by shopping around.

    As for your general comments, there may be some truth to it. But I think that’s more true of the internal risk/profitability models that various lenders and insurers have more so than the FICO score. Those, unlike the FICO, actually have more detailed information on you like employment and income information. I think what you’re saying is definitely true about the way auto insurers use credit scores (the scores are more of a predictor of whether people will file claims than whether they are safe drivers).

  8. johnva says:

    @UpsetPanda: She doesn’t know what she’s talking about. The FICO score does not take income into account. Individual lenders might, however.

  9. dallasmay says:

    I got a new Mortgage for a duplex in Dallas last November and our interest is locked at 5.375%. I love playing lenders off of each other. (By the way Wells Fargo is the bank we ended up going with. Credit score 740ish)

  10. chiieddy says:

    My sister was just quoted 6.15% on a 30-yr FRM for a house she just signed on today. I believe rates are regional to a certain extent.

  11. CrystalCheer22 says:

    As someone who works for a direct lender for mortgages in a market like this, credit means quite a bit. It used to be a 620 was a good enough score to avoid any additional fees in a loan. Now, if you have less than a 740 you are looking at discount points adjustments for risk on ANY FannieMae/FreddieMac loan. Credit bureaus would like your credit cards to carry less than a 25% balance-to-limit ratio at all times. If you have a credit card with a $1000 maximum limit, you should have less than $250 on it at the time of reporting. These are things that a lot of mortgage lenders don’t tell you. Income does not change your credit score, but your debt-to-income ratios may mean a loan approval or a loan denial. 5.799% is not available in the mortgage market as of today.

  12. Buran says:

    @UpsetPanda: I think that just means “don’t use up all your available credit”.

  13. @UpsetPanda: One criticism is that you more or less HAVE to do things that involve debt to DEVELOP a credit history — credit cards, student loans, fail to pay bills on time. Paying cash for everything and never being late on a bill will result as you being a FICO non-entity, which requires you to get non-traditional underwriting for a mortgage, since they can’t just pop your numbers through a formula, and some banks these days resist dealing with folks who don’t have a FICO score.

    You CAN develop a credit history just by having a line of credit you never use, though I don’t know how “good” it is. At least it wouldn’t be a bad one. For most of us it isn’t a problem, but it CAN unfairly penalize financially stable folks who avoid credit entirely.

  14. Me - now with more humidity says:

    mollyg: Wrong. It’s a “how do you manage credit and debt” score.

  15. samurailynn says:

    @SuffolkHouse: Wow… my FICO is only about 640 and I still got 6.5%

  16. johnva says:

    @Eyebrows McGee: You can develop a GREAT credit history just by using a credit card and paying it off in full every month. No need to pay interest or go into debt (for more than a month).

    However, you’re right that you may have trouble if you don’t have ANY credit history. That also kind of makes sense, because they have no basis to judge how you would handle credit. You could be really good, or you could be part of the percentage of people who are really high risk. Since they can’t tell, they may lump you with people with a demonstrated bad credit history.

  17. ShortBus says:

    @Eyebrows McGee: It’s a common misconception that being is debt is a bad thing. Debt is a good thing–if managed properly–since debt allows you to leverage more money than you actually have on hand. It’s that second, really important part that most people never figure out though.

    And yes, it would be pointless for someone to open an account and never use it. FICO scoring takes into account “date of last activity”. Zero activity = zero benefit. DoLA is an even more important part of FICO ’08 scoring.

  18. greensmurf says:

    Great now I have that Credit report.com song going on in my head, crap…

  19. crazylady says:

    @johnva: Exactly. One of my friends stayed the hell away from loans and cards for most of her life and then got burnt when she tried to add her husband to a family plan from AT&T, who refused citing her nonexistant credit. I would assume they’d accept a deposit and years worth of paying AT&T bills on time but nope.

    She eventually got something like 5 credit cards she uses to pay the bills and pays in full all the time. But she’s annoyed by that because she doesn’t think she needs to even have one card.

    It’s sort of lame.

  20. VotaIdiota says:

    Quite a bit of wrong information going on in the comments:

    Here it is, folks, as simple as I can put it:

    YOU DO NOT NEED TO PAY A CENT OF INTEREST TO HAVE A GOOD CREDIT SCORE.

    Use cash for everything? Go out, get a credit card (a no-annual-fee one, obviously. I don’t even understand people paying for these things), and use it for everything you already buy (this is important: don’t start buying things you wouldn’t before). When your bill comes, pay the “Statement Balance” in full before the due date. Congratulations! Thanks to the beauty of grace periods, you now have a 30 day interest free loan on all the things you were already purchasing before.

    Every month, when a new statement is generated, the cc company will send that snapshot out to the CRAs. The important part is that each time they send a new one to the CRAs, it will show you have paid up for that month. Want to get a higher credit score relatively faster? Get a second card, put 50% of your spending on one, and the other half on the other. Boom, you’ve now got two accounts reporting monthly to the CRAs showing you’re paying on time. It won’t show that you’ve paid the full statement, but that doesn’t matter. If you’re carrying too much month to month (still not having to pay interest, remember, cause statements and charges overlap), log into your card’s account page, and click the good ol’ credit line increase button. You should be able to get an automatic increase every three months or so.

    It’s really not all that hard, folks.

  21. mac-phisto says:

    the system is far from perfect:

    on the borrower side, small collection items (say an etf you refused to pay years ago) can have a disproportionate impact on your score. hospitals (which are notorious for sending items to collection before sending you a bill) can also wreak havoc on your score. also, revolving credit seems to have a disproportionate effect on your credit as opposed to term loans. & despite the new “consumer-friendly” legislation, fixing an error is still a process that requires the attention to detail that normally results in a paxil prescription from your doctor.

    on the lending side, there are also issues. quick example – it seems as if there is a lessened impact of “length of credit history”. i’ve reviewed applications for young borrowers (18-24) that are walking around with 700+ scores & they have maybe an entry or two on their report. what’s the problem? it’s an inaccurate indicator of risk. just b/c jack has a 700 doesn’t mean he should be driving around in a brand new audi at the age of 19…but he is. there are kids living at home, making <$25,000/yr & they have $500/mo. car payments. they never should have been approved, but with little actual history, they were. & as a lender, we’ll be lucky if we don’t have to pick up that car in a year.

    for reasons such as this, the loan office i work in uses more traditional methods for approval (DTI ratio, proof of income, length of employment & other “stability” factors, etc.) & we actually review the report line-by-line. it’s irresponsible as a lender to rely entirely on the score for approval.

    unfortunately, the market rules. if i deny jack his audi, he goes to someone with less scrupulous standards. & in his eyes, my office will forever be the bad guys that wouldn’t give him the loan. it’s hard to impress on people that sometimes you’re doing them a favor by saying no.

  22. loganmo says:

    About a month ago, Wachovia offered me 5.5% on a fixed-rate 100% financing and my score is 708!

  23. missdona says:

    @SuffolkHouse: I’m over 800, I locked a 5.75 to a property about 2 months ago and then that fell through. I had to settle for 6.375 for the property I wound up getting.

  24. missdona says:

    And they were 30 year fixed, no points. I wonder if they’re counting points..

  25. Mojosan says:

    what is the legit website where you get get your credit score for free once per year?

  26. missdona says:

    I don’t know one that gives the score, but annualcreditreport.com is where you can get your report from all 3 agencies once a year.

    [www.ftc.gov]

  27. mac-phisto says:

    @Mojosan: no one gives you our score for free (although [www.myfico.com] occasionally has promos that you can sometimes find on sites like dealhacker). some credit cards have free report offers or will give you a free report if you sign up for credit monitoring or something similar.

    just please stay away from freeSCAMcreditreport.com.

  28. Me - now with more humidity says:

    greensmurf: I loooove those commercials… “I’m stickin’ to the seat and my posse’s getting laughed at…”

  29. cmdr.sass says:

    Some mortgage lenders will send you your FICO score for free if you make a refi inquiry.

  30. @timmus: Word! Paying for a score is just asinine.

  31. sleze69 says:

    @Mojosan: No one gives scores out for free. [www.annualcreditreport.com] is the official government sponsored website that will give your report for free.

  32. sickofthis says:

    @Landru: We just got 5.25.

  33. Coelacanth says:

    @johnva:

    The credit score formula has no idea whether you are “living withint your means” and “avoiding debt as much as possible”

    Well you’re right that credit histories and scores don’t examine a person’s income, they can usually infer the ability for one to “live within one’s means” by looking at utilisation ratios. A person who has high-limit cards and relatively low balances demonstrates they have good financial responsibility. On the otherhand, a person who maxes out their cards probably is not.

  34. deadlizard says:

    Obsessing with credit scores is definitely good business for the bastards who invented it.

  35. @johnva: Yeah, and that’s what I do. I was thinking more about the folks who completely and totally object to credit cards, period, whether they’re paid off in full every month or not. :)

  36. rioja951 - Why, oh why must I be assigned to the vehicle maintenance when my specialty is demolitions? says:

    @mac-phisto: Well, right now I’m thanking whoever denied my loan for my car.
    Now I’m driving a axela speed (mazda speed 3 in the US) and laugh when driving past the dealership that denied me, since I’m driving a more expensive car.

  37. johnva says:

    @COELACANTH: That still doesn’t necessarily tell whether you are “living within your means”. You could still be spending too much and paying it off (from savings, perhaps). Or you could have really high credit limits in relation to your income (since the credit scoring formula has no idea what your income is). Even the banks that issue your card often have little idea of your income. For example, I have one credit card that I got quite some time ago when I was a student and had almost no income. I have not given them any other information about my income since then (though they could probably infer that it’s higher based on my spending/paying off other cards on my credit report). So they can guess at what I’m making now, but they don’t really know.

  38. Kmoney says:

    I know someone who has a 463 and got a 5.125% fixed through NACA…how many people just exploded with rage?

  39. hexychick says:

    Score doesn’t mean shit lately. Car dealers and any other seller that offers financing reviews the report as well and if you’ve got any black marks, you’re screwed. I had a 725 rating when I went to buy my truck last June and no matter what I did, I couldn’t get a lower rate than 11% because of a deliquent account I had many years ago. (Yes, I was younger and stupid, but I have learned from it and never made that mistake again.) I also tried to finance a new bed last month but was denied for this same delinquent account so I paid in cash. My score is only 5 points lower since the truck too.

  40. sixseeds says:

    A friend of mine said his credit score went down after he paid off his grad school loans. Apparently you get a better score from paying a big debt off regularly than you do from having no debt at all. To me this suggests the whole thing is a huge scam that doesn’t measure your creditworthiness so much as your potential profitability.

  41. econobiker says:

    Yeah, a good payment history / good credit score can increase the amount you pay for some stuff. Progressive insurance (motorcycle) charges more for someone who has less than 5 open lines of credit.

    The explanation pried out of their risk / underwriting dept. is that someone with better financial management is MORE apt to file a claim for payment than someone with lower financial management skills. IE if you are good about managing your money, you are more likely to file a claim to get Progressive’s money… I have had that insurance since at about 1989 through today (2 year gap living in NJ) and never filed a claim…

    Progressive also wanted to see an open card / line of credit from before to age 25. Both in 2006 and 2007 I had to re-educate them that I did infact have a credit card since I was 18 ( and I am now 39!!!!). Maroons…

  42. johnva says:

    @hexychick: I’d be willing to bet they were just trying to scam you. Some unscrupulous car dealers will try these “financing was denied” games in order to try to get you to agree to a worse loan that is more profitable for them. The best advice is that if you do need to finance a car, go through your bank or credit union. I’m betting you wouldn’t have had that problem there. I don’t think the problem was your credit history so much as the dealer’s greed.

  43. knyghtryda says:

    As someone who’s under 25 with a credit score over 800… another sometimes overlooked impact is insurance payments, especially car insurance. Car insurance for the under 25 set is brutal, but with a good credit score it can shave a good chunk off payments. I’ve had quotes vary over $100 a month depending on if they took into account my credit score or not.

  44. johnva says:

    @econobiker: Your explanation doesn’t make much sense to me, because it’s the opposite of my understanding of why auto insurers use credit scores. In general they charge LESS for people with good credit scores because those people are LESS likely to file claims. This is probably because those people are more likely to have money saved up (and maybe to have a higher income) and therefore are less likely to need to file a claim over minor damage or whatever. (In general, it saves you money to have a high insurance deductible, avoid filing claims for minor damage, and use your insurance only for really bad stuff…which should be the real reason you have insurance in the first place). Also, having less open lines of credit is not necessarily a sign of better “financial management”. I have many more than that, but I don’t use most of them most of the time. I have them mainly because I use each of them for specialized purposes, in order to maximize cashback rewards and minimize things like foreign currency exchange fees.

  45. econobiker says:

    @johnva: You make exactly the point I made to the risk folks at Progressive. Progresssive apparently changed their evaluation criteria in the past two years- at least for the state of TN. Maybe if you DON’T have multiple lines of credit they figure you will HAVE to file a claim versus putting repairs on a card. The person I spoke to -did- say that the less than 5 open lines of credit was not a huge impact on the rates.

    And about the deductable- this is for base liabiity insurance without any fire/theft/collision etc no deductables!!! My motorcycle is worth less than $1500 on the open market.

    Progressive does figure alot of pertainant info though-like that a 250cc Honda Rebel motorcycle is used by a lot of novice riders and higher rate than similar cycles up to 500cc may apply due to typical novice rider inexperience – who usually insures for collision also.

    Point I was making is that some company are now using credit scores for more than just lending money…

  46. johnva says:

    @econobiker: Weird. I wonder if it’s different for motorcycles for some reason. My insurer (State Farm) told me I was saving a significant amount of money on my car policy due to having a good credit score (about 40%!). But yeah, it’s totally true that credit scores are used for much more than just lending. Insurance is the biggest one, but they are also used as part of background checks by some employers, and increasingly by landlords if you want to rent a house or apartment. People really need to be aware of this stuff before they decide that they don’t need to worry about their credit score. Credit scores are no longer just about debt!

  47. dsgnomite says:

    You also forgot to mention down payment. You put enough money down (say over 25%) you won’t need a score or proof of income for that matter.

  48. hexychick says:

    @johnva: Normally I’d agree with you, but it was a used car – new was way out of my price range. Their financing (Ford credit) couldn’t do better than 15% so they tried a few others till it got down to 11%. My own bank couldn’t do better than 13%. My insurance company said that after a year of good payments they’d try to finance it for a lower rate. It was actually the best car buying experience I’ve ever had. I’ve walked out of other dealerships for that kind of BS but this one was really great as far as dealerships go.

  49. Dont Know Me? You Are Me. says:

    Here’s a free FICO score tip: I have a HELOC and auto loan with my my credit union. I call the loan dept up a couple times a year and they are happy to give me my FICOs. No charge.

  50. the_wiggle says:

    @Kmoney: at least one didn’t. a low score can happen for reasons beyond a person’s control – medical, divorce, downsizing. . . .