How FICO Scores Affect Interest Rates

When you apply for an auto loan, mortgage or another type of loan, lenders look at more than your income. Your FICO score says a lot about your credit habits and lenders check this number to determine your creditworthiness. However, this three-digit number not only affects loan approval, but also your interest rate on a loan.

About FICO Scores

FICO scores, also called credit scores, are three-digit numbers that range from 300 to 850. The higher your FICO credit score, the better. This indicates good credit habits, such as timely payments and low consumer debt. Credit scores are periodically recalculated -- about every 30 days -- and it's normal for credit scores to fluctuate. Several things can lower your score, such as collection accounts, judgments, a foreclosure, bankruptcy and other derogatory information. Lenders and creditors check credit reports and credit scores before extending a loan or line of credit. People with high scores typically qualify with little hassle, whereas a low credit score can stop a credit approval.

FICO Scores and Interest Rates

While FICO scores play a huge role in the approval process, they also play a role in interest rates. Interest is what you pay a lender or creditor for use of the financing being extended to you. While current market trends determine the average interest rate on car loans and mortgages, your FICO score determines whether you receive a competitive rate or a high interest rate. For example, if applying for a mortgage loan, an applicant with an 810 credit score may receive a mortgage with a low rate of 3.75 percent. An applicant with a 680 credit score may receive an interest rate of 4.25 percent. That's a monthly difference of $60 on a $200,000 loan. A high FICO score indicates a low credit risk. It indicates you are less likely to default on your payment or send a late payment. Low credit risk equals a lower interest rate.

Improving Your FICO Score

Order your personal credit score from MyFICO.com before applying for any type of loan. In a matter of minutes, you can access each of your credit scores from the three reporting bureaus -- Experian, Equifax and TransUnion. With your credit score in hand, you can decide whether now is the right time to apply for financing. The minimum credit score for financing varies by bank, but the higher your score, your better. Aim for a score of 700 or higher. This is considered good credit by many lenders, and a score within this range opens the door to favorable interest rates. If your score is less than 700, add points to your FICO score by paying down your debts, paying your bills on time and disputing errors on your credit report.

Consideration

Whether you have an excellent credit score or an average credit score, it pays to shop around and compare loan offers. Never accept the first offer you receive from a lender. While your FICO score affects your interest rate, lenders don't always quote the same rate. By shopping around, you receive multiple rates from multiple lenders. Thus, you can pick the lender that charges the least for the loan and save on interest payments.

About the Author

Valencia Higuera is a freelance writer from Chesapeake, Virginia. She has contributed content to print publications and online publications such as Sidestep.com, AOL Travel, Work.com and ABC Loan Guide. Higuera primarily works as a personal finance, travel and medical writer. She holds a Bachelor of Arts degree in English/journalism from Old Dominion University.

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