Why Your Credit Score Matters When Applying for a Loan

Why Your Credit Score Matters When Applying for a Loan

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Have you ever wondered why lenders and other financial entities obsess over credit scores? A good score means you’re a responsible borrower who reliably repays loans on time, so understanding them can make nearly all the difference in your financial journey. 

What Are Credit Scores?

Credit scores represent your creditworthiness or reliability as a borrower. Lenders generally use them to assess the risk of loaning you money—the higher your score, the more trustworthy you appear. A rating of 700 and above gives you a better chance of being eligible for a credit card or loan with low-interest rates and reasonable terms.

Also, several credit scoring models exist, with FICO Score and VantageScore being the most popular in the United States.

4 Main Factors Influencing Your Credit Score

The following aspects impact your credit rating, so keep them in mind throughout your financial journey.

1. New credit

Opening doors to new credit is a double-edged sword. While it offers opportunities for financial growth, each new application might leave a mark on your report. Accumulating too many hard inquiries—new lender requests for your credit file—may indicate financial stress or risky borrowing behavior.

2. Current credit

This factor refers to your credit utilization ratio or the credit you use in proportion to your limits. A high utilization may suggest financial strain, so aim to keep it low to demonstrate responsible credit management.

3. Payment history

All lenders favor borrowers who make timely payments. Hiccups in a credit report, be it a missed payment or a default, make the entire transaction risky. So, strive for a flawless payment history so that lenders can be confident in your ability to meet your obligations in the long term.

4. Length of credit history

A good credit score is also about how long an account has been with you and how well you’ve kept up with their payments since you opened them. Closing old accounts might seem like decluttering, but it could negatively impact your creditworthiness. On the other hand, having multiple new accounts may indicate risky financial behavior.

Read: What Is The Difference Between A Super Fund And An Smsf?

Credit Scores and Loan Applications

As mentioned, credit scores give lenders an idea of your creditworthiness, and a higher score gives you a better chance of acquiring loans with favorable terms and interest rates. At the same time, a poor rating may urge lenders to raise interest rates to compensate for your perceived risk or disqualify you entirely from their loans.

While a credit score above 700 is ideal, it still varies depending on your lender and loan type. For instance, mortgage terms generally last decades, so lenders are often wary about risk. In fact, an upper 600 score could be rated 0.399% higher than an upper 700. Meanwhile, most car loans only last a few years, so lenders are more willing to take on higher risks.

How to Maintain Your Credit Score: 5 Strategies

Let’s discuss some tried-and-tested strategies to help maintain or improve your score.

1. Pay your loans on time

Consider this the golden rule of credit score management. Late payments signals lenders that you might be a risky bet. Hence, you should practice better spending habits and automate payments to never miss a due date. Remember, your payment history carries significant weight, so prioritize keeping it spotless.

2. Don’t max out your credit limit

Use your credit limit as a safety net rather than a spending target because maxing out your cards makes your credit utilization ratio soar. Aim to keep your credit balances below your limits—ideally below 30%—to demonstrate responsible credit management and ensure a buffer during financial emergencies and unforeseen expenses.

3. Apply for new credit only when needed

Don’t apply for every enticing credit deal. Each application triggers a hard inquiry on your report, and a flurry of inquiries within a short period raises red flags. Instead, consistently assess whether an application is necessary and how it aligns with your financial goals to maintain a stable credit profile.

4. Review your credit reports

Your credit report contains a detailed review of your credit history, including open accounts, payment history, and derogatory marks. So, make it a habit to check your report regularly to spot inaccuracies and potential issues that could impact your credit score.

If you didn’t know, you’re entitled to weekly reports from the three major credit bureaus—Equifax, Experian, and TransUnion. 

5. Leverage credit monitoring tools

Your credit profile changes rapidly as you pay off loans and bills, so much so that it can be challenging to keep track of them. Fortunately, credit monitoring tools can give you real-time updates on changes to your credit, which you can use to optimize your profile and spending habits further.

Keep Your Credit Score in Mind

Remember, your credit score is an investment in your future financial health. When you pay your loans on time, balance your credit utilization, and make strategic decisions about new credit, you lay the groundwork for a profile that gets more favorable terms and opportunities.

It’s your turn to take action to improve your future loan applications. Explore more resources and tools to deepen your understanding of credit health—the more you know, the more empowered you become.