Editorial Policy

New year boosts free credit scores

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By Eva Norlyk Smith, Ph.D.
January 7, 2011

When applying for a new mortgage, credit card or other type of loan, are you getting the very best interest rates and loan terms available? After all, your credit report and credit score affect not just whether you’ll get approved for a new credit card or mortgage loan, but also the loan terms lenders will offer.

Up until now, consumers have been in the dark about how exactly their credit score was affecting loan terms when applying for a new loan. Thanks to new rules that stepped into effect January 1, 2011, there will be far greater disclosures.

The new rules are part of the so-called “risk-based pricing” rules under the The Fair and Accurate Credit Transactions Act of 2003 (FACT Act), which require lenders to inform consumers when they are offered different interest rates and/or loan terms because of their credit score. The new disclosure rules were put in place to make the process of shopping for a credit card or loan more transparent to consumers, and enable them to make more informed choices about the credit they take on.

Many consumers are not aware just how much having an excellent credit score will affect loan terms. The purchase APR offered on credit card, for example, can range from 12.99 percent to 19.99 percent or higher, depending on the creditworthiness of the applicant. Similarly, for mortgages, an applicant with excellent credit (i.e. a FICO score of 760 or higher) may receive mortgage rates that are as much as four percentage points lower than those offered to people with average or fair credit, e.g. 5.99 percent compared to 9.99 percent, according to BankRate.com. Over the span of a 15-30 year mortgage, those four percentage points will translate into tens of thousands of dollars in savings.

Savings on interest expenses are not the only way that better loan terms benefit people with excellent credit. Because the interest costs and monthly loan payments are lower, people with excellent credit are often able to afford a more expensive home.

The new, mandatory credit score alerts applies only to consumers who are offered an interest rate higher than that offered to other consumers. Lenders can use one of two ways to alert consumers. They can supply credit applicants with a notice that they are being charged a higher interest rate because of their credit rating or send everyone who applies for credit a free copy of the credit score used to make the lending decision, as well as information about how the score compares to those of other applicants and information about how to challenge mistakes on their credit report. Experts predict that the latter action may prove to be more attractive to large banks, because it automates the process and voids the need to make decisions about who to send notices to on a case-by-case basis. For most consumers, getting a free copy of their credit score will also be the more desirable of the two.

The FACT Act led to the establishment of AnnualCreditReport.com, where consumers can get a free copy of their credit report once a year. Up till now, credit scores have only been available for a fee.

The timing of the new mandatory credit score alerts is particularly good, since credit scores are more important than ever. After more than two years with record mortgage foreclosures and high credit card defaults, lenders have increased standards for what is considered excellent credit for both mortgage and credit card applications, and it is far more difficult to get the very best terms. Now, at least, consumers will have the satisfaction of knowing just exactly how their credit score measures up, how it affects the loan terms offered and, in some cases, what they might be able to do to improve their credit score and hence loan terms.