Your FICO Score can have a rather large impact on the interest rate that a lender will charge for any line of credit, such as a mortgage, loan, or credit card.
In this post, we’ll explain the relationship between your credit score and your interest rates, and how that connection can possibly affect you financially.
The higher your credit score (also known as your FICO Score), the better the interest rates you’ll usually receive.
But what might be considered a good credit score? Credit scores can possibly be thought of as one of five different ranges:
Lenders might offer lower interest rates to borrowers with “Excellent” or “Very Good” credit scores. Sometimes, they’ll use these optimal interest rates to advertise their loans or products to potential customers but then offer customers with a “Fair” or “Poor” credit score higher rates.
People with “Good” credit can potentially pay about 0.2% more above the advertised interest rate for “Excellent” credit scores. From there, if your credit score goes down 20 points, it might result in further increases in the rate you’ll pay.
While most people think of their interest rate as a single number, such as a 20.0% APR (annual percentage rate), the truth is much different. It’s important to first know how does credit card interest work.
Credit card companies often actually charge you a daily rate. For instance, that 20% APR can be divided by 365 to reveal a daily rate of 0.0548%. This is how much interest you can be charged every day on your outstanding balance.
This interest might also build on top of any previously charged interest. Then, all of this collective interest could compound and grow even faster the longer the balance remains unpaid. That’s why people can quickly spiral into credit debt if they’re not careful.
To make matters more complicated, interest rates are often variable and subject to change. For example, let’s say you missed a payment on your credit card and your FICO Score dropped. The card issuer may detect this missed payment and possibly raise your interest rate.
You can protect yourself against rising credit card interest rates with two primary methods:
Keep your credit score up. Simple things like making your payments on time, meeting the required monthly payment, and keeping your balance low will all go a long way towards maintaining a healthy credit history. Beyond your credit card usage, a good credit score will also help you qualify for other financial necessities like loans, refinances, and insurance.
You might be able to avoid interest charges completely. Keep your spending low and manageable. That way, you can possibly pay off your credit card bill in full every month. By paying your statement balance each month within the grace period, your card issuer most likely won’t charge you any interest, so it might not matter what happens to the interest rates.