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Credit: What it is and the Main Reason Why It’s So Important

Having a Credit Card as a 10 year old was the best financial decision ever!

Yes, really! I had a credit card at 10 years old. While some people may roll their eyes at my parents for this, it was the best decision they could have made for my financial future. Before we get into it, let's first understand what credit is.

Basics about Credit:

Credit is the ability to borrow money to access goods and services with the understanding that you will pay that loaned amount back later typically with a fee in the form of interest. A strong credit history will allow you more flexibility in your future financial decisions.

Examples of Credit:

Credit and loans work hand-in-hand where most forms of credit are loans, for example mortgages, auto loans, and student loans.

The most commonly used form of Credit is in Credit Cards. Credit is typically used in situations to purchase a product or service you can’t pay for immediately, think of them as a short term loan. All forms of credit require an application based on your credit history.

Good vs Bad Credit:

Good and bad credit is described by your 3-digit Credit Score. Experian, one of the top credit reporting companies, describes the typical range for credit scores as follows:

  • 300 to 579 - Poor. 16% of Americans

  • 580 to 669 - Fair. 17% of Americans

  • 670 to 739 - Good. 21 % of Americans

  • 740 to 799 - Very Good. 25% of Americans

  • 800 to 850 - Perfect. 21% of Americans

Why Credit is SO important - Access to the BEST loan Products

Having a Credit Score that is “Good” or better, over 670, will let a loan provider know that you have a reputation of paying off your debt consistently. This will allow you access to better loan products, specifically a better interest rate on your loan.

There are other benefits like being approved for an apartment or job application. However, the single greatest reward for having good credit is your ability to secure a lower interest rate on different loans which can save you thousands of dollars over your lifetime.

A high loan interest rate can dramatically increase your monthly loan payment and cost you more in the long term. It is important to note that different types of loans have different ranges for their interest rates; they can even vary by state or even the product you are using the loan to purchase. A great example of this is the Build & Price estimator from Toyota.

You can choose your dream car with all the features you want. Then play around with Payment Estimator and you’ll see the difference in price when you change your estimated credit score.

I did this for the new Rav 4 and found that having an excellent credit score will reward you with an interest rate of 1.90%. If you have a Fair Score or what Toyota describes as “Poor Credit Score” between 609 and 580 points, you will be penalized with an interest rate of 14.95%. That’s approaching the rate of some credit cards!

*** Note: The below screenshot is from Toyota. These rates and offers may be updated at the time you try this out. ***

Payment Estimator based on Toyota
Toyota Credit

But what does this mean for your cost?

Using Toyota’s Price Estimator, you’ll see that the monthly payment will jump from $462 (Excellent Credit) to $702 (Very Poor). Over the life of the loan, having poor credit will end up costing you over $15,000 in just interest payments. Reference the chart below:

Play around with your own numbers and compare your interest rates with this spreadsheet.

All this to say:

The better your credit score, the cheaper you can borrow money for! This isn’t restricted to Auto loans as in my example but will apply for any loan and contract terms you will encounter throughout your life.

The lower your interest rate, the lower you will pay over time!

But what does this have to do with me having a credit card as a 10 year old? My parents added me and my siblings as authorized users to their credit cards but never gave me the card. They paid it off every month and started building my credit so when I went to apply for an apartment and a car loan I was able to qualify for the best options.

I am extremely fortunate for this and I realize you may not be in the same position. In my next post, I will describe the main factors that impact your credit score and how you can build credit!

Stay Tuned!

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