Explained: How Credit Score Affects Your Loan Interest Rates

The past decade or so has been a witness to how a credit score has taken over the role of being no less than a crucial financial asset in everyone¡¯s lives.

From being one of the most important eligibility criteria for approval of loans and credit cards, to even being a part of employee background checks by organizations in some sectors, the horizon of credit score¡¯s role has been broadening.

And that's not all. Many banks and other financial institutions have also given another huge role to credit score, i.e. the setting of lending interest rates based on an applicant¡¯s credit score.

So, not only does your credit score impact your loan approval chances, but even your loan¡¯s interest rates!

Understanding Risk-Based Pricing

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Also Read: Why It's Important For Millennials To Check Their Credit Report Every Month

Simply put, lenders have started practising an approach called risk-based pricing.

Under this, applicants with a good credit score are offered lower interest rates on loans as a ¡®reward¡¯ for being disciplined with their past repayments of credit card bills and loan EMIs. On the other hand, applicants with low or no credit scores are offered relatively higher interest rates, as they tend to pose a bigger risk of default or irregularities in loan repayment.

But why levy higher rates on those with weak credit scores? Its because those with low credit scores clearly indicate a lack of discipline in credit repayments, which in itself increases associated credit risk for the lender.

And those with no, i.e zero credit score, are the 'new to credit' applicants who have not borrowed any loan or have any credit card yet, which implies they don't have a credit history to show a repayment track record, lack of which again poses higher credit risk.

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What About Those Already Repaying Loans?

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Not only is the credit risk pricing practice a reward for credit disciplined new applicants, but it is also beneficial for existing borrowers of home loans, personal loans, car loans etc., who are maintaining a disciplined credit repayment record. Existing loan borrowers with a good credit score are often offered lower interest rates by other lenders in the form of balance transfer offers.

This way, the existing credit disciplined loan borrowers can further reduce their loan interest rates applicable for the outstanding loan amount.

Also, those with good credit scores stand higher chances of fetching pre-approved loan offers too, given their disciplined repayment record, which reduces the credit risk of irregularities or loans default.

So. Overall, whether you are an existing borrower or a prospective applicant for a loan, remember that credit score can be your best friend to strike the best loan deals at low-interest rates!

Also Read: Why Your Credit Score Can Fall Despite Timely Payments!

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