What You Didn’t Know About Credit

Credit Scores and APRs – Joined At The Hip
The interest rates charged on credit-card balances are known as Annual Percentage Rates (APRs). These rates reflect the perceived creditworthiness of credit-card holders. Generally speaking, consumers perceived to be good credit risks can expect to pay lower rates. Conversely, consumers that are perceived to be worse credit risks can expect to pay higher rates.

The Four Horsemen of Credit: Bureaus, Reports, Scores, and Cards
Credit bureaus are companies that stockpile credit data and sell it to qualified firms engaged in issuing credit to consumers. These credit bureaus assemble the available data, analyze it, and create credit reports. These reports are then sold to credit issuers both in a raw format and in an analyzed format.

The raw credit report is complex and will be the subject of another blog post. The analyzed form of a credit report is a credit score. This score is usually a number. Higher credit scores reflect better credit risk. Lower credit scores reflect worse credit risk. Consumers who want to own credit cards need good credit histories and high credit scores.

Credit Scores and APRs – An Example
Let’s assume that a credit bureau creates scores that range from 1 to 10, with 1 being the worst and 10 being the best. Assume further that credit-card issuers analyze the market for credit cards, and decide that they can make money if their average cardholder has a score of 6 or higher. Under these circumstances they turn down all applications they receive from consumers with scores of 5 or less.

Consumers who have scores of 6 or higher who want credit cards can apply, but the issuer uses APRs to reflect the risk each cardholder represents. Depending upon the state of the economy, the credit-card issuer might offer APRs ranging from, say, 10% to 15% (these numbers have been selected to make this example easy to understand). The credit-card issuer might assign cardholders with credit scores of 6 an APR of 15% to reflect the higher risk associated with a lower credit score. Cardholders with credit scores of 10 under this scenario would receive the best APR – 10%.

Higher Credit Scores Mean Lower APRs
Here’s the key point: a high credit score indicates a good credit history – and lower financial risk to a credit-card issuer. If you have good credit, you can expect to receive a better APR. You can also expect to have a larger credit limit, but that topic will be the subject of another post.

Protecting A High Credit Score
The simplest way to protect your credit score is to monitor your credit report closely to make certain that it is accurate and complete. Most credit bureaus compile the following information: all current credit accounts, all current loans (including mortgage loans), all closed accounts, all retired loans, and a continuous history of your home addresses. Your credit score might change modestly from month to month; however, if you note a significant change (and particularly a change for the worse), question it immediately.

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