In my previous posts about credit cards, I’ve mentioned that building up a good credit score is one of the benefits of using credit cards.
I also briefly went through various things that are affected by your credit score, but not in as much detail as you’d probably want to know.
After all, if you’re going to freak out over something you’ve never heard of, you wanna make sure that it’s actually important, right?
In this post, I will try to explain why exactly your credit score matters – whether you’re a working adult or a student.
What Is Credit?
Credit basically refers to money that is not yours.
So whenever you buy something with a credit card, you are not paying for it in cash at the point of transaction, but rather with credit.
This credit is usually money that belongs to the bank, and the banks trust that you will pay them back for what you have spent.
So the whole system of credit only works if the banks can reasonably believe that you can and will repay them – and the metric they use for this is credit score.
What Is A Credit Score?
According to the Credit Bureau of Singapore’s (CBS) website, credit score is defined as the following:
“a number used by lenders as an indicator of how likely an individual is to repay his debts and the probability of going into default. It is an independent assessment of the individual’s risk as a credit applicant.”
Basically, it is a measure of how likely you are to miss your payments. It ranges from 1000 ~ 2000, where a credit score of 2000 indicates the lowest probability of missing a payment (the best score).
Why Does It Matter?
1: Loan Approvals
Sooner or later, there will come a time where you need to take up a loan with the bank.
But the problem is that even though everyone will probably need a loan, banks are not obligated to give everyone a loan. This means that you may not end up getting the loan you need.
Without a loan, you may be denied of opportunities like becoming a homeowner, starting your own business or getting your PhD – which can end up being major roadblocks in your life plans.
If you have a good credit score, you’ll have a much better chance of getting your loans approved than someone with a poor/unknown credit score.
As mentioned earlier, banks will only give you money if they believe that you can and will pay them back.
And the only way for them to know that is if you have a good credit score – because that means you manage your finances well and have a good history of repayments.
Conversely, if your credit score is unknown or below a certain threshold, banks may not be willing to loan you any money at all.
This is because banks don’t want to take the risk of you never repaying them their money.
So if you want the highest chance of getting your loans approved in the future, a good credit score is crucial.
2: Cost of Loans
Ok, so maybe your credit score is high enough to get you the loan you need. The next question is: how much is the loan going to cost?
One factor that affects the cost of your loan is the interest rate, which is something that can be impacted by your credit score – where a high credit score yields a lower interest rate and vice versa.
This is because a higher credit score means banks will be more confident in you repaying them in full – so they may be willing to make a smaller profit from you.
Due to the effect of compound interest, small variations in interest rates can cause the total cost of your loan to vary by large amounts, especially when the repayment period is long.
To give you an idea of how your total interest paid will vary with interest rates, check out this table for a principal loan of $500k, assuming a 30 year payback period.
|Interest Rate (%)||Total Interest Paid ($)|
Disclaimer: All numbers were obtained using an online calculator, and numbers will vary depending on the principal amount and payback period.
As you can see, a difference in interest rate of 0.1% translates into an additional $10k of interest payments, while a difference of 0.5% can result in paying an extra $50k – all for nothing.
That’s crazy, right?
I don’t know about you, but I hate the idea of having to pay more money without getting any extra benefits or perks.
Having a good credit score gives you more bargaining power to negotiate for the lowest interest rate on loans – which can ultimately lead to huge cost savings in the long run.
3: Job Opportunities
Your credit score can also affect your job opportunities in future, especially in finance.
To your prospective employers, your credit score basically serves as an indication of how capable you are at managing credit and how trustworthy you are.
While this may seem like a stretch, it all comes down to first impressions – which employer would feel comfortable about hiring someone who has not taken care of their financial health, to make solid financial decisions for them?
If you’re not looking to get a job in finance, you can relax because employers outside of finance typically don’t look into your credit score.
Having a good credit score is important because it affects:
- Loan Approvals
- Cost of Loans
- Employment Opportunities
I am not saying that having a good credit score will guarantee that all your loans will be approved, that you will be able to bargain your way to your desired interest rate or that you will land your dream job.
But it guarantees that you have a better chance than if you had a bad credit score.
Ultimately, the benefit of having good credit score is to maximise the opportunities available to you in the future.
As the saying goes, it’s better to have it and not need it than to need it and not have it.
Regardless of whether you’re a student or adult, it would be a good idea to take care of your credit score.
Now that you know how a good credit score can benefit you, the next thing you need to know is how to build your credit score, and I’ll cover that in a separate post soon!