When you apply for a credit card or loan, lenders typically use what’s called risk-based pricing to determine whether to approve your application and what interest rate to charge.
If your credit score is high, data shows that you’re less likely to default on the new account than someone with a low credit score. As a result, you can usually expect to score a lower interest rate, which will save you money over the life of the loan.
For example, let’s say you apply for a $30,000 auto loan and want to pay it off over five years. If you have excellent credit, you may qualify for a 3.5% annual percentage rate (APR), which will give you a monthly payment of $546. In this case, you’d pay $2,745 in interest over five years.
However, if you have fair credit, you may qualify for a pricier 8% APR. This would increase your monthly payment to $608, and you’d end up paying $6,498 in interest over the life of the loan. In this scenario, having great credit would save you $3,753.
Of course, lenders consider more than just your credit score. They may also look at your debt-to-income ratio—how much of your gross monthly income goes toward debt payments—as well as specific items on your credit reports, such as recent inquiries, delinquent payments and more.