When you apply for a new loan, a lender peruses your credit report to check your payment behaviour in the past. Defaults will result in a lower credit score, meaning a higher interest rate. With an impressive credit report, you will qualify for lower interest rates.
Although a poor credit rating is to blame for higher interest rates, the fact is that turning to a lender to tide over during emergencies is not a good sign. It demonstrates that you do not manage your money well.
However, it is not always a bad idea as a lender wants to see whether you stick to payments that you cannot prove unless you borrow money. Experts suggest you stow away some money to fall back on when you are cash-strapped, regardless of your income.
A high credit score means higher credibility. It is what a lender evaluates after looking over your credit file to know whether you are eligible for a new account. Your payment track will be taken under advisement to ensure that you will keep up with payments this time.
A lower credit score calls your creditworthiness into question. A lender may not turn you down straightaway but will charge a higher interest rate as high risk is to be borne by them.
The role of credit scores in determining interest rates
Your credit report plays a paramount role in a lender getting a peek into your financial behaviour. No lender is loaning you without the intention of getting your money back. No matter how strong the reason you had to fall behind in payments, it is all but impossible to win the trust of a lender. After all, seeing is believing.
For instance, if someone has an excellent credit score, it means that they made all their payments on time, and this does not just include debt obligations but rent and energy bills. Having all accounts in good condition will make your lender confident that you will repay the debt fully on time.
As a lender has no reason to be sceptical about your repaying intention, they will let you enjoy the benefit of lower interest rates. You can benefit from lower interest rates when you apply for a mortgage or car loan.
In fact, a lender would not ask for a higher deposit. Technically, lenders charge a higher interest rate to recover their losses in case you make a default.
A low credit score could result when you fail to keep up with payments due to either you taking on too much debt and then ending up running out of money or your account had been sent to collection agencies, and it had a bankruptcy or permanent default.
You will be regarded as a borrower with very high risk. Chances are a lender will straightaway turn you down. If they anyhow sign off on it, interest rates will be too high.
Another reason for resulting in a lower credit score is you never borrowed money. A borrower with very little or no credit history cannot make a lender believe that they would manage to pay off the debt on time.
A lender might not be comfortable to loan you. If they sign off on your application, interest rates will be higher. When you have a bad credit rating or have no credit history at all, a lender might turn you down when you borrow a loan for an extended period, but you will be eligible to small emergency fund like a loan in 15 minutes.
Tips to improve your credit score to get better interest rates
Having a good credit score is not just worth the while to secure lower interest rates. It has a lot of other benefits you can experience down the line. Try to improve your credit rating so you can qualify for a lower interest rate.
Avoid maxing out your credit cards
If you use plastic, you might get carried away and keep forking out money. When the due date falls, you eventually find that you do not have money to pay back the balance. Make a rule not to use up more than 30% of the entire balance of your credit card. It is wiser if you bring it down to 25%.
Pay off bills on time
Missed payments can ding your credit score, and your credit points will quickly plummet as the number of missed payments goes up. Make sure that you clear all your dues on time. You should also worry about other obligations like rent payments, energy bills, etc.
If you have missed the due date, try to clear the outstanding amount as soon as possible, within 30 days. Inform your lender how many days it will take to clear dues. If you are past 30 days, your lender will inform credit reference agencies of your default, and then it is too late to reverse the damage.
Do not close accounts for no reasons
If you have multiple credit cards, do not close a few of them, even if you do not use them. This is because it will keep the utilisation ratio low. A credit score is determined based on multiple factors, and one of them is the credit utilisation ratio.
If you close them, it will reduce the balance and increase your utilisation ratio. To avoid paying annual fees, talk to your credit card provider if it is feasible to keep the account open but with lower fees.
The final comment
You will undoubtedly get a loan with a lower interest rate if you have a high credit score because it shows your credibility. However, if you have a lower credit rating, you will end up bearing higher interest rates.
Interest rates will be higher when you have built no credit history at all. Try to do up your credit report if your score is not so good before taking out a loan. The more impressive your credit file is, the better it is.