How credit scores affect interest rates

When opening a new credit card or applying for a loan, your credit history matters in more ways than one.

Your credit score plays a big part in determining whether you can get approved for credit, as well as the interest rates you pay. If you’ve never given much thought to the link between credit scores and interest rates before, here’s what you need to know.

How are credit scores and interest rates related?

The relationship between credit scores and interest rates is straightforward on the surface.

“In a nutshell, the higher your credit score, the lower the interest rate that you’ll qualify for and vice versa,” said Kari Lorz, personal finance expert and founder of Money for the Mamas, in a previous interview. 

A lower interest rate is a lender’s way of rewarding you for good credit habits. However, that doesn’t mean a higher rate is a punishment for having poor credit.

“It’s their own form of internal insurance on you as a customer,” said Lorz. Lenders can charge a higher rate to compensate for the possibility that, based on your past credit history, your odds of paying late or defaulting might be higher.

How credit scores impact credit card rates

Your credit card’s annual percentage rate, or APR, represents the annualized cost of carrying a balance when your interest rate and card fees are factored in. Credit scores help determine the interest rates and fees credit card companies charge you, said Howard Dvorkin, personal finance expert and chairman of Debt.com. 

“A lower credit score may tell lenders a person is not likely to pay back a loan, and this increases a consumer’s APR,” said Dvorkin.

Higher APRs make carrying a balance more expensive over time. For example, say you charge $5,000 to your travel rewards card to book a vacation and you plan to pay $250 a month toward the balance. Assuming a 17.25 percent APR, it would take you 24 months to pay it off and cost you $938 in interest charges.

However, a low credit score can result in an APR of 22.25 percent instead. You can still pay the balance off in 26 months, but you’ll pay a total of $1,306 in interest. The difference in your card’s APR will cost you nearly $400 more. To know how long it’ll take to pay off your credit card debt, check out our credit card payoff calculator.

Note that while credit scores matter for determining APRs, there are some things you can’t control.

“A factor you can’t influence is the national prime rate,” said Lorz.

This is the interest rate at which banks lend to their most creditworthy customers. 

The prime rate is tied to the federal funds rate, which is determined by the Federal Reserve. Usually when the federal funds rate changes, the prime rate changes the same amount. And when the prime rate changes, so do credit card APRs, though it’s not required.

How to lower your credit card APR

Getting a good interest rate on a credit card or another type of loan comes down to making yourself as attractive to lenders as possible.

“It’s hard to 100 percent ensure that you’ll get a good APR on your credit score alone,” said Lorz. “However, you do have a good bit of control on your rate just with your score.”

Improve your credit score

The best way to leverage that control is to work on improving your credit score, said Dvorkin. “This can be achieved by paying your bills on time, every time, and not maxing out your credit cards but, conversely, paying them off in full every month.”

While loans do affect your credit score, credit cards tend to have a greater impact on credit utilization, which is the total amount of credit you’re using compared to your total amount of available credit. If you’re working on improving your credit score to have a shot at better APRs, be sure you’re choosing the right cards to do it.

Review your card’s terms and conditions, fees, APR and benefits at least once per year so you know what you’re paying for and what you’re getting in return. Resist the urge to close older accounts unless they offer absolutely no value, because that could hurt your credit score in the short run. (Closing a credit card account can decrease your overall available credit, which could inflate your credit utilization ratio.)

Also, consider opening a new credit card account with more favorable terms or features — but be strategic about it. Each new inquiry for credit can trim a few points off your score, so take the time to research which cards are the best fit based on rewards, card perks, APR, fees and your needs.

Request a lower APR from your issuer

If you have a credit card with a high APR and you’re interested in lowering your interest rate, consider calling your credit card issuer and requesting a reduction. You may have more success if you have a history of on-time payments and you have a good credit score. 

It’s best to start with the card you’ve had the longest since your credit card issuer will be more likely to reward your loyalty. To further increase your chances of success, do your homework first and prepare to speak to a representative. It may be helpful to know your credit score and have information about other offers, with lower APRs, available from competing companies. You may need to call multiple times before you are successful in getting a lower APR.

Bottom line

Credit scores are typically broken up into ranges, and each range is assigned a different score rating. Understanding those ranges can help you get a better sense of what you might pay in interest based on which category you’re in. While credit card companies usually don’t disclose the minimum credit scores they require to qualify, many specify whether a card is designed for fair, good or excellent credit.

If you’re in a category that doesn’t give you access to the best rates, start working on improving your credit score so down the line you can request a lower score. Worst case scenario: Those struggling to make payments can try asking their issuers for a temporary break in paying interest, if necessary.