You have the chance to start your credit history early. By the time you’re trying to buy your first house, your credit score will have matured to an impressive number.
What is a Credit Score?
You probably already know that your credit score defines a lot of aspects of your life like your ability to get a loan. Simply put, your credit score is a three-digit number that assesses your creditworthiness. As gross as “creditworthiness” may sound, it’s pretty important — companies use it to determine how reliable you are and how likely it is that you’ll pay back the loan offered.
Someone with a low credit score appears less likely to pay back their debts because they have a history of being late on payments, not paying bills, and keeping a high balance on existing credit cards. However, someone with a high credit score has proven to make regular payments and has a good credit utilization ratio.
A credit utilization ratio is one of the most important factors used in determining your credit score. The ratio is calculated by determining how much available debt you have and how much is being used. For example, having a lot of available debt, but only utilizing a low percentage is good. You can figure out your utilization ratio by dividing your total credit card balances by your total credit card limits.
Your credit score will determine whether you’re eligible for a loan, but it also locks in an interest rate. Good credit means a lower interest rate while bad credit equals a higher one. So, let’s say you’re finally buying your first car. You have your down payment ready, and you picked out the cutest little Toyota Corolla. The car dealer will run your credit score to determine an interest rate on your loan (or whomever you choose to get your loan through).
Someone who has a credit score of 770 may get a low interest rate of 3.04% interest on a $20,000, 60-month auto loan. At the end of the loan, this person will end up paying approximately $1,583.77 in interest.
If we compare this scenario to someone who has a low credit score of 600, the loan will be less favorable. For the same loan, the interest rate could be as high as 5%. After 60 months, the interest charged will total out to $2,645.48 — that’s an extra $1,061.71 for the exact same car!
A Lower Score is Harder to Improve
The common thought is that you don’t need to worry about your credit score because you can start working on it when you’re older. Unfortunately, the truth is that a low score can take some time to improve depending on how bad it dipped south.
Let’s compare it to your GPA. If you just started college, you don’t have a lot of credit hours. You have two semesters under your belt, and you’ve had relatively good grades — except you don’t do well in History and you get a D. Ouch. That one mistake will drop your GPA pretty low, and you’ll have to get A’s and B’s in every class to bring your GPA back up to an acceptable level.
Your credit score is the same way. If it drops down to 600 or lower, you’ll have to work extra hard to bring it back up — it may even take a decade or more to reach 770. And remember what I said earlier about things costing more? You’ll end up paying more money for things you want while simultaneously paying off the debt you accrued previously.
The worst part is, after you start improving your credit score, the stain of late payments and defaults will remain on your credit report for seven years. It doesn’t matter if you’ve made steady payments for five years. That one late payment from half a decade ago will still show up and drop your credit score.
Even if you think the two aren’t related, landlords may not agree. One in two landlords said the results of a credit check were among the top three factors used when determining whether to accept a tenant’s lease application.
As credit checks for rental properties increase, people with bad credit scores may find themselves living in less-than-desirable places. You probably want to live near your friends so you can hang out during the week, go the bar, or catch up on the latest episodes of Gilmore Girls. Unfortunately, a low credit score could keep you from living where you’d like. Building and maintaining a good credit score ensures you’ll have more control over where you want to live.
It Could Increase Your Car Insurance
You already have plenty of other bills to pay—phones, lights, rent, etc. — but those with poor credit could also end up paying more in car insurance premiums. It’s a controversial subject, but some states allow car insurance companies to run your credit to determine your monthly insurance cost.
Consumer Reports found that someone with a low credit score could pay on average as much as $68 to $526 more per year when compared to drivers with the best credit scores. In states like Kansas, a moving violation increases the premium by $122 on average per year.
Moral of the story: having a good credit score and managing your money could save you in ways you may have never considered.