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Why is credit score important?

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If you are new to personal finance, you may be wondering what all the hoopla about your credit score is, and why it is actually important? It seems like it might be overblown, but when you actually assess the financial impact that it can have on you, it’s easy to see that it is one of the most important financial numbers out there.

The most clear way to see this is to look at the amount of interest you would pay on your mortgage and how large of a mortgage you could receive, depending on your credit limit. A good way to see this would be to look at the examples from this August 2013 article from US News.

Scenario 1: Low FICO of 620-639

With a relatively low FICO score (at least when it comes to applying for a mortgage) of 620-639, you could expect to pay 5.671 percent in interest. This would mean you could borrow up to about $232,299, giving you the power to purchase a home for about $252,299 once you add your down payment.

Scenario 2: Mid-range FICO of 660-679

In the middle of the pack with a FICO score of 660-689, you could expect to pay about 4.695 percent interest. This would let you borrow up to $259,291 for a total home price of $279,291.

Scenario 3: High FICO of 760-850

With this top-notch FICO score, you may qualify for a premium rate of just 4.082 percent. This would allow you to borrow up to $278,749 for a total home price of $298,749.

As you can see from the examples, the difference between a high credit score and a low credit score could mean a $50,000 difference in the type of home that you could buy.

Next, let’s use his interest rates, and see how much interest you would pay over the life of a loan for the same mortgage, but with different interest rates depending on your credit score. We’ll use a mortgage of $250,000, just for consistency sake (using bankrate’s mortgage calculator).

Scenario 1 – With a 5.671% interest rate, you would pay $270,707.59 in interest, bringing your total paid to $520,707.59.

Scenario 2 – With a 4.695% interest rate, you would pay $216,503.59 in interest, bringing your total paid to $466,503.59, or roughly $54,000 less than the person with a poor credit score.

Scenario 3 – With a 4.082% interest rate, you would pay $183,939.30 in interest, bringing your total paid to $433,939.30, or roughly $33,000 less than someone with ok credit, or roughly $87,000 less than someone with poor credit.

That just shows you the importance of your credit score! It really drives home the point that you have to do everything you can to increase your credit score.

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