Your credit score helps determine what interest rate you qualify for. Read on to learn how the two are related and what you can do to get a lower APR.
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,” says Kari Lorz, personal finance expert and founder of Money for the Mamas.
Think of it this way. A lower interest rate is a lender’s way of rewarding you for good credit habits.
That doesn’t mean a higher rate is a punishment for having poor credit, however.
“It’s their own form of internal insurance on you as a customer,” says 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, says Howard Dvorkin, certified public accountant and personal finance expert at 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,” says Dvorkin.
Higher APRs make carrying a balance more expensive over time.
Say you charge $5,000 to your travel rewards card to book a vacation. You plan to pay $250 a month toward the balance. Assuming a 17.25% APR, it would take you 24 months to pay it off and cost you $938 in interest charges.
Now, say a low credit score results in an APR of 22.25% instead. It’ll now take you 26 months to pay off the balance but your total interest paid jumps to $1,306. The difference in your card’s APR costs you nearly $400 more.
You can run your own numbers using CreditCards.com’s credit card payoff calculator.
Note that, while credit scores matter for determining APR, there are some things you can’t control.
“A factor you can’t influence is the national prime rate,” says Lorz. This is the interest rate at which banks lend to their most creditworthy customers.
“If it goes up, so does your APR,” she says.
How to improve your interest rate
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% ensure that you’ll get a good APR on your credit score alone,” says Lorz. “However, you do have a good bit of control on your rate just with your score.”
The best way to leverage that control is to work on improving your credit score, says 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 have an impact on your credit score, credit cards tend to carry more weight with regard to credit utilization. If you’re working on improving your credit score to have a shot at better APRs, make sure you’re choosing the right cards to do it.
Review your card’s terms, 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 since 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.)
And 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 and fees.
Credit scores can be broken up into ranges, with each one assigned a different credit 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 do specify whether a card is designed for fair, good or excellent credit.
|Credit score range||Credit score|
|800 to 850||Exceptional|
|740 to 799||Very good|
|670 to 739||Good|
|580 to 669||Fair|
|300 to 579||Very poor|
If you’re in a category that doesn’t give you access to the best rates, start working on the ways we pointed out to lower your interest rate so down the line you can pay the least amount of interest possible.