Why Is Your Credit Score So Important?

Lauren WardUpdated August 9, 2023

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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.

Your credit score is a three-digit number that can have a big impact on your life in many ways, so it’s smart to understand why it’s so key. Your credit score is a reflection of your credit history, and that’s one of the primary factors in determining whether or not you’re approved for credit and how much you’ll have to pay in interest if you are approved. Your credit score also has the potential to impact your job, your living situation, and your insurance policies. In this article, we’ll explore how these areas are affected by your credit score, why your credit score matters so much, and how you may be able to improve it.

What Is the Main Purpose of a Credit Score?

Your credit score is a way for creditors to evaluate how large a risk it would be to lend you money. If you have poor credit, a credit card company or lender may be concerned that you’ll miss payments and potentially default on the card balance or loan. That’s why your application is more likely to be declined, and if you do get approved, you’ll probably have to pay higher interest rates. Having a good credit score can open the door to better financing and terms. You’re less likely to need to use collateral in order to secure a personal loan, for instance, and you could qualify for credit cards with better terms and stronger rewards programs.While your credit score isn’t typically the only factor lenders use to review loan applications, it’s a major one, which is why it’s important to have good credit.

How Can a Credit Score Help You?

Working to build your credit score can result in several major benefits in addition to better financing opportunities. These include:

Lower auto insurance premiums. For most Americans, your credit score influences how much you pay for your auto insurance premium. According to the Insurance Information Institute, 95% of insurance companies use your personal credit score as part of the application review process. However, some states, including California, Hawaii, Massachusetts, and Michigan, do restrict or prohibit insurers from using credit scores to determine coverage approval.
Stronger rental applications. A strong credit score can also help you stand out when it comes to rental applications. Landlords often require a credit check, with a particular focus on your payment history, to gauge how likely you are to pay your rent on time.
Waived security deposits. After you get your place, having an established credit history and a good score may let you avoid paying a security deposit on your utilities. The amount of the deposit typically requested varies by company, but you could end up having to pay up to two months of your average bill in advance. The deposit is usually returned once you make consecutive, on-time payments for a set number of months, but the initial outlay may be challenging.
Better job opportunities. Finally, your credit is important because it can influence your career path. Some jobs require a good credit score, especially if you’re handling money. In fact, research shows that 16% of employers pull credit checks on all job applicants, and nearly 30% perform a credit check for some positions.

What Factors Affect Your Credit Score?

There are many factors that may affect your credit score. FICO®, the most widely used credit scoring model, breaks them down into five separate categories.

Payment history: Your payment history is the most important component of your credit score because it shows how you’ve handled borrowed funds in the past. If you have a strong track record of paying your bills on time (particularly your credit cards and loans), then you’ll score well in this category.
Amounts owed: You can have outstanding debt and still have good credit. But you may experience a credit score drop if you’ve maxed out your available credit. So even if you make all of your minimum payments on time, you may be penalized if you carry a large balance on your credit card, especially in relation to your credit limit.
Length of credit history: Your credit score also factors in how long you’ve been using credit. The age of all of your accounts is averaged, so opening new credit lines can cause a dip in your score, and it often pays to keep your oldest accounts open (unless you’re paying a high annual fee).
Credit mix: The types of credit accounts you have open also matter to your score. In addition to credit cards, your score could benefit if you diversify with things like installment loans, retail accounts, or a mortgage.
New credit: The age of your accounts impacts your credit, as does how frequently and how recently you’ve opened new accounts. Your score could drop if you apply for several new credit lines in a short period of time, since it could signal a financial emergency.

How to Maintain a Good Credit Score

FICO scores range from 300 to 850, and the average credit score in America since April 2021 is 716. That’s considered “good,” so if you’re close to that number (or even if you aren’t), there are a few steps you can take to help maintain and even build your score. Make your credit payments on time: If you’re 30 days late on a payment, that delay can be reported to the credit bureaus and stay on your report for seven years. Avoid maxing out credit cards: Keep your balances low so that you don’t have too high a credit utilization ratio (which compares how much credit you have access to and how much you’re actually using). It’s ideal to keep your balance below 30% of your credit card limits. Keep old accounts open: Avoid closing your oldest accounts since age is a factor in your credit score. An exception to this rule might be if you’re charged a fee for a credit card or line of credit that isn’t offset by a rewards program or some other type of benefit.Recommended: How to Get Cash Back With a Credit Card

Is Credit Monitoring Useful?

Credit score monitoring is a good way to track your score and find out if the changes you’re making are helping your credit. The level of service you receive depends on the company and plan you select. The basics of credit score monitoring services involve ongoing updates whenever your score changes. You may even get real time alerts when a change occurs. This can be helpful to know if the change happened because of something you did or because someone stole your identity and opened a fraudulent account in your name.

How Much Does Credit Monitoring Cost?

Wondering how much credit monitoring costs? In some cases, you may get free access through your bank or credit card company. But if your financial institution doesn’t offer this perk, then you can either pay or choose a free educational credit service. Ongoing credit monitoring typically requires a monthly fee. For premium services, that may range from around $8.99 to $39.95. A free service, on the other hand, can save you some cash, but may not use the same scoring model as most lenders. So while the free version gives you an idea of where your credit stands, the actual scoring may differ when you apply for a loan.

How Does a Business Credit Score Differ from a Personal Credit Score?

Both your personal and business credit scores matter when you’re applying for small business financing. However, there are some differences between the two. Your business credit score factors in things like your company’s payment history, but it also involves an evaluation of your company financials, risk factors, and more. Why is your credit score important when you own a business? Your loan terms depend on the strength of both your personal and business credit history. It’s difficult for new businesses to qualify for startup loans or lines of credit since there’s no business history, and it becomes even harder if you, as the business owner, have bad credit. Entrepreneurs with good credit can bootstrap their businesses using business credit cards and can optimize personal loans with better terms.

The Takeaway

The importance of your credit score lies in its impact on your ability to get approved for quality financing. With a good score, you’re more likely to qualify for low-interest loans and credit cards when you need them. Find out what rates you’re eligible for now by comparing credit card options from multiple lenders with Lantern by SoFi.

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About the Author

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.

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