Having a really high credit score is good, but it’s not quite as important as you might think. For lenders, a higher score generally means you’re less risky, and that you are more likely to pay back what you’re loaned. They use the numbers as a sort of ranking system, and they’ll offer you lower interest rates and better terms than those with lower scores. But what isn’t as widely known is that increasing your credit score has diminishing marginal returns. Beyond a certain point, it simply doesn’t matter if you nudge that score any higher.
The Smiths and the Browns each show up at the bank looking for a mortgage. The Browns have a sterling report and an exceptional FICO score of 830 (a perfect score is 850). The Smiths have a few minor “dings” on their credit reports and score 760, still a very good credit rating. Who gets the lower mortgage rate?
It’s a trick question; they both get the same rate.
The “magic number” on mortgage loans for many banks is 760, although there is no one score cutoff. One lender may offer you the lowest interest rate on a car loan if your credit score is above 700; another may use 720. And with credit cards, 740 or above will generally secure you the best deals. So once you hit the mid-700’s, it’s all gravy after that.
Now enter the Cooks. Their credit score is 690 due to some late payments on a credit card and an old student loan. Although the difference between their credit score and the Smiths is 70 points – the same point spread as between the Smiths and the Browns – the bank will quote the Cooks a higher interest rate.
Are you the Cooks or the Browns? And how should you manage your score?
While both the Browns and the Smiths can rest easy, the Cooks would benefit by getting their credit score up. Since more than half of your credit score is based on your payment history and what you owe, it makes sense to focus on those areas first. There are a couple of steps that the Cooks (and anyone suffering from bad credit) can take to clear that mid-700 hurdle.
First and foremost, pay every credit bill on time. Even one late credit card or mortgage payment means a hit to your score. If you’ve been late in the past, brush it off and resolve to do better. Set email reminders or establish an auto-pay system, and if you’re having trouble making payments, contact your creditors or a legitimate credit counselor to help you better manage payments.
Credit scores also reflect how much credit you have available to you. Keep balances low on credit cards since maxing out your cards lowers your score, and don’t be afraid to ask for higher credit limits to decrease your utilization. Don’t close unused credit cards since that decreases your available credit. By the same token, don’t open new cards to increase your available credit: that strategy can backfire.
Meanwhile, if you’re sitting firmly in 800-territory, you can probably take a deep breath and relax. Don’t be afraid to open new accounts solely to take advantage of their sign-up offers or bonus credit card rewards. That’s money in your pocket and will only cost you a few points on your credit score in the short-term. This won’t meaningfully affect your loan rates in the future.
Many FICO-fiends also take out unnecessary loans for their cars and such, solely to tweak their credit scores. But if you can afford to pay cash and your credit score is already good enough, you’re just giving up good interest money for no reason.
This article comes from Tim Chen, the founder and CEO of NerdWallet.com, a website that helps consumers to compare credit card offers. Tim also educates consumers about credit cards and debt management at the Forbes Moneybuilder Blog, the Huffington Post, and the Christian Science Monitor.