Updated: Mar 17, 2022
It would probably make most of us sick to our stomach to see someone flushing tens of thousands of dollars down the toilet. And yet, that is essentially what happens to some individuals who have fallen prey to a nasty predator—high-interest rates.
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Credit Cards and Interest Rates
Credit card companies not only make money on the fees they charge retailers to be able to accept payments, but they also charge cardholders interest and fees. The interest is typically expressed as an annual percentage rate, or commonly referred to as the APR. Although "interest rate" and "APR" are often used interchangeably, there is a difference in the meaning of the terms. But, in this article, we won't dive into the difference.
Most credit cards have variable APRs that will fluctuate based on the prime rate. Credit card issuers will generally offer someone with a higher credit score a better APR, and vice versa with a poor credit score.
Most credit card companies will charge a cardholder interest if they do not pay their bill in full each month. And, to make matters worse, if a cardholder does not pay their bill in full the next month, they will be charged interest on the interest they were charged the preceding month, thus compounding interest. That is one reason why credit card balances can easily escalate.
What Is a Credit Score?
A credit score is a numerical value used to predict the likelihood of default. It is used by credit card companies to determine if an individual is a high-risk borrower or not. The mainstream consumer credit models used to determine a credit score are FICO and VantageScore. The numerical value consumers are ranked range from 300 to 850. 850 is a perfect score but is probably out of reach for the majority of consumers!
Credit reports and credit scores are very important—not only when applying for credit cards—but for just about anything requiring a credit check. This includes applying for a mortgage, an auto loan, cellular service, and even with a utility provider. Some insurance companies may use your credit score to help determine your auto, home, and life insurance premiums. Some employers may review your credit report before making a hire, or promoting a current employee. A strong credit score will give a consumer more access to competitively priced credit and better options that would otherwise be unavailable to them.
What Is a Good Credit Score?
What determines a "good" credit score is an arbitrary one. It is up to each lender to make that determination. In any event, there are "ranges" FICO and VantageScore use that provides a close approximation as to whether a consumer may be classified as having poor, fair, good, or excellent credit. For example, FICO classifies "Poor" as 300 to 579; "Fair" as 580 to 669; "Good" as 670 to 739; "Very Good" as 740 to 799; and "Exceptional" as 800 to 850. Hence, a good rule of thumb is to try to attain a credit score of at least 740.
Interestingly, some lenders are willing to lend more liberally and extend credit to consumers who have a lower credit score whereas other lenders are more conservative, and may deny credit to a consumer who would otherwise have been approved by one of its competitors. The bottom line—your miles may vary.
How Is My Credit Score Calculated?
Your credit score is generally based upon the following: payment history, credit utilization, length of credit history, types of accounts, and recent activity. For example, FICO considers scoring factors in the following order: payment history—35%; amounts owed—30%; length of credit history—15%; credit mix—10%; and new credit—10%.
Based on this model, it is pretty easy to identify the two biggest factors that go into a credit score—payment history and credit utilization.
Payment history is straightforward—making on-time payments on your credit accounts helps your scores. However, missing payments, collection accounts, or bankruptcy filings will hurt your scores.
Credit utilization just refers to the amount of revolving credit that you are using divided by the total amount of revolving credit available. For example, if a cardholder has a $10,000 limit, but only carries a $2,000 balance, their credit utilization rate on that card is 20%. It is generally a good idea to keep your credit utilization less than 30% of the total amount of revolving credit available.
Your length of credit history involves the average of all your credit accounts. It includes the age of your oldest and newest accounts, with older accounts helping your scores.
Your credit mix, or types of accounts, considers whether you have both installment accounts (e.g. mortgage, auto loan, etc.) and revolving accounts (e.g. credit cards, etc.). Showing that you can manage both types of accounts responsibly will usually improve your scores.
How Can I Improve My Credit Score?
A healthy credit score is a similar process as being physically healthy. It takes effort, planning, and self-control.
Generally, the most important aspect to consider is to make at least your minimum payment and make all of your payments on time. Ideally, you want to be able to pay your balance in full every month. This will prevent you from being charged interest.
Probably the second most important aspect is to maintain low balances with all of your credit accounts. If possible, try to keep your overall utilization rate in the single digits. This shows potential lenders that you are responsible with the amount of credit available for you to use.
Another factor to consider is to make sure your open credit accounts are reported to the credit bureaus. This includes both installment and revolving accounts. If these types of accounts are missing, potential lenders will not be aware of your credit history, which could lower your score.
Because increasing the average age of your credit accounts could help your scores, you typically would not want to close your oldest credit card account. It is debatable whether or not you should close any existing credit card account. Although there may be some scenarios where this would be a viable option for you, there are benefits from keeping your credit card accounts open—even if you don't use them anymore.
Another debatable topic is to only apply for credit when you need it. Applying for a new account will usually lead to a hard inquiry, which may hurt your credit scores for a short period. And, applying for multiple new accounts within a relatively short time frame could hurt your scores even more.
Nevertheless, it is important to compare the pros (e.g. welcome bonus, etc.) and cons (e.g. dip in your credit scores, etc.) of applying for a new credit card. If you're not sure what to do, contact a Credit Card Miles & Points Consultant. With their experience, they will be able to provide you with the tools you need to make an informed decision.
What if My Credit Score Is Below Average?
Although it may take time, you can improve your credit scores! A good starting point is to apply for a credit card to demonstrate to potential lenders your ability to make all of your payments on time. You'll be able to build credit, practice good credit card habits, and prove your creditworthiness over time. However, you may need to settle for a "less-than-average" credit card.
If you are looking to build your credit, an unsecured credit card for you may be the Reflex Mastercard®. Consider this card a "gateway" to getting approved for other credit cards in the future that offer rewards and other benefits. You can apply for this card here!
If your credit score is below 580, you may need to apply for a secured credit card. This is a type of credit card that requires a cash deposit as collateral. One excellent secured credit card to consider is the Platinum Secured from Capital One. A minimum deposit of $49, $99 or $200 is required and it provides the path to an unsecured credit card. You can apply for this card here!
If you currently have a credit card balance, feel free to use our Credit Card Calculator. It will determine how long it will take to pay off your balance based upon your monthly payment amount or the monthly amount required to pay your balance off within the selected number of months.
How Do I Benefit From a Good Credit Score?
Having high credit scores could make the difference between qualifying or being denied for a home mortgage, auto loan, or desired credit card. In addition, being approved for one of the aforementioned types of credit accounts while carrying low credit scores could translate into a higher interest rate—paying hundreds or even thousands of dollars more—than having high credit scores and being offered a lower interest rate.
"The benefits of good credit scores not only saves money; it saves time and energy as well."
When it comes to the amount of interest paid throughout a credit account, few types of accounts compare to that of a mortgage. Having low credit scores can easily result in tens of thousands of dollars in extra interest by being offered a higher interest rate.
That is why choosing a mortgage company—and a loan officer—is a critical financial decision not to be taken lightly. Seth Stidham of CrossCountry Mortgage, LLC, is primed and ready to help you with your home loan. He offers a wide range of loan programs, from FHA and VA to conventional and jumbo. His character is stellar and he has an impeccable reputation of integrity. Whether you are a first-time homebuyer or a long-time homeowner, consider contacting Mr. Stidham of Cross Country Mortgage, LLC.
Having high credit scores also leads to being approved for some of the best credit cards. For example, the Chase Sapphire Preferred—The Best Credit Card Just Got Better! Right now, the Chase Sapphire Preferred® Card is offering a 60,000 Chase Ultimate Rewards® welcome bonus! Although Chase values the 60,000 points at $750, by strategically using one of Chase's 14 transfer partners, it is possible to get a value of over $1,000! You can apply for this card here!
Other excellent credit cards offer amazing redemptions. Are you unsure of what card to select? Try our Credit Card Selector Calculator for FREE! It uses our proprietary algorithm which determines the best credit card in our database based on your spending habits. You will be able to determine the value of each credit card in your first year of use and make your selection accordingly.
The Tortoise Wins the Race
Do you feel overwhelmed with all the "credit jargon" contained in this article? If you do, you are not alone. It can be frustrating to try to decipher all of the factors that go into credit scores. Nevertheless, in the iconic parable, the slower tortoise wins the race by beating the faster hare. The point? Slow and steady wins the race. A similar principle can be applied in the credit ecosystem we are all connected to.
Take things slowly. Learn credit basics. Don't try to do anything unethical. Demonstrate credit responsibility. Don't make assumptions—ask questions to those who have been successful at running the credit "race." If you take all of these points seriously, you will be on your way to possessing good credit scores!