At it’s basic definition, credit is the ability to pay for a good or service after you’ve already received it, with the understanding that the person taking out credit will make the payment in the future. In many cases, credit comes with an additional charge on top of what the good or service costs. This charge that allows you to pay afterwards is called interest. Many consumers in the U.S. use credit to buy just about anything you can think of, and if not used responsibly, this can lead to problems and financial difficulty.
Using a credit card is fast, easy, and very convenient. However, it’s also a fast and easy way to enter into debt. In fact, most households in the U.S. today have thousands of dollars of credit card debt, and that doesn’t include other types of debt such as student loans and home loans. The total amount of consumer debt in the United States has reached over $11.4 trillion.
The Cost of Borrowing & FICO Score Range
Borrowing money may seem like the ideal solution when you need to purchase a large-ticket item but don’t have enough money in your current situation to do so. By borrowing, all of that money is ready for you to use. Sounds great, right? But there’s always a cost. This cost comes in the form of interest rates and fees. When taking out a home loan, your lender will probably incur an origination charge, the VA funding fee, and charges for an appraisal, among other costs. These fees and the added interest rate make up the cost of borrowing. At the end of the loan, when everything has been paid in full, you as the borrower end up paying an incredible amount more for that large-ticket item than you would have if you’d paid for it out of pocket. Even so, for some goods, paying out of pocket simply won’t be an option, but there are limits to what and when you can borrow money, and most of those restrictions depend on credit score.
There are a few different companies that provide the software necessary to calculate your score and each will have a slightly different scale. By far the largest and most well-known company is FICO, which stands for Fair Isaac Corporation. FICO credit ranges anywhere from a 300 to an 850. The higher the score the better, and these numbers are broken down into categories of quality:
Excellent: 800 – 850
Very Good: 750 – 799
Good: 700 – 749
Fair: 650 – 699
Poor: 600 – 649
Very poor: 300 – 599
“Excellent” credit places you in the upper echelon of FICO credit society. As long as there isn’t anything glaringly wrong with your profile, an excellent score will almost always get you approved for loans, credit cards, etc. This score explains that you’ve kept up with payments, you don’t put a lot of expenses on credit, and you are generally a financially responsible person. “Very good” credit is only slightly less glorified than excellent. Even here, you will be approved for most everything, and you will still qualify for great rates and terms. In the next level, “good” credit, you might feel slightly more tentative. Approval rates here are still very high and rates will be good. They just won’t be “very good” and “excellent.”
The next level is where things start to get sticky. Usually when a person sits at a “fair” score, they are entering financial difficulty or just pulling out of it. From this point, it isn’t too difficult to pull your credit higher into the “good” category. It might take a few simple months of good financial practice. However, lenders will delve deeper into your credit history to see why you’re in this category. If it’s because of several missed payments, you might get denied again and again. Understand that the 650 to 699 credit score is not a horrible place to be in. But you should also not get complacent here. Build up good practices in order to feel secure in your credit.
“Poor” credit is exactly what you’d guess: poor. No one wants to be here and no lender wants you to be there either. It is very difficult to get approved for a loan or credit card when you already have poor credit. If you are in this category and you do get approved, it is likely your interest rate will be very high and you may have to pay much larger down payments on houses in order to purchase them. I know, it seems kind of backwards since extravagant expenses are probably how people with poor credit got there in the first place. Even so, expect that if financial hardship got you here, financial hardship will follow you until you pull yourself out.
The final level is “very poor.” The most common ways that a person enters this category are because of a few active collections, a bankruptcy, a repossession, or an active judgement. Another reason may be because you are new to establishing a credit history. If this is the case, it can be relatively easy to build up your status to a better rating. If this isn’t the case, the next reasonable step would be to contact a credit counselor. Together you can make a plan to successfully improve your financial situation.
Credit Score Needed for a Mortgage
So, what do lenders and others who check credit deem a good and acceptable score? The average FICO score in the U.S. is a 680, but when talking about an acceptable credit score in general, this could be anything 650 or higher. For home loan requirements compared to credit card companies, the definition of “good” fluctuates a bit, and the same is true between companies in the same business field. For example, one home loan company that does conventional home loans might require the borrower’s credit score to be close to 700 while a VA home loan company might have a very low requirement or no concrete requirement at all.
Your credit score tells the lender of your home loan how responsible you are with your money. The lender does not want to lend out hundreds of thousands of dollars to someone whose credit score indicates the lender may never see his or her money again. If you work hard to get your credit score into the “excellent” and “very good” categories, you’ll likely qualify for amazing interest rates that will keep the cost of borrowing down low.