If you’ve seen people on social media talk about building wealth, you’ve probably heard them give tips on reducing spending, paying off debt, and earning more, but you may not hear much about credit scores. Credit scores are a less familiar topic because their impact on a person’s financial life can be ambiguous.
However, if used correctly, a strong credit score can unlock a new world of wealth building. A stronger credit score can make buying a home, renting an apartment, or getting a car more accessible and affordable. Paying less for these fundamental needs can free up money for other wealth-building ventures like starting a company, investing in stocks or real estate, or even paying down debt faster.
In honor of National Financial Literacy Month this April, we’re breaking down why a healthy credit score is crucial in helping you build and maintain wealth.
Credit gives you access to homeownership
For many people, owning their own home is an essential part of the American Dream. Homeownership is more than an idyllic goal, however; owning property is a primary driver of generational wealth. Home prices tend to appreciate slowly over time, so the value of your home will likely be more than you paid for it as the years go by.
For most, the only path to homeownership is through a home loan, also known as a mortgage.
There are different types of mortgages, but access to any kind relies heavily on your credit score. Your score is essential in determining how much the bank will lend and at what interest rate (the price you pay for borrowing the money) you will be charged to borrow money. Over the life of a mortgage, interest payments can total well into the hundreds of thousands.
To buy a home, most people pay between 5-20% of the purchase price on a home upfront and borrow the rest. Mortgage lenders require a minimum credit score of 620, but generally, the higher the credit score, the lower the interest rate on the loan.
If you’re just starting on your financial or credit journey, homeownership may feel far away, but it can be achieved and is an important part of building wealth.
Business loans depend on your credit
Another way to build wealth is to start a business. While a mortgage is somewhat straightforward, a business loan can be more complicated. Whether you plan to turn a hobby (like baking or photography) into an additional income stream or work on your business full-time, you may need additional money to start.
A business loan can fund any part of your business venture, from paying photographers and freelancers to postal service costs. Many new business owners find it more convenient to get an infusion of cash upfront than pay for things little by little based on income so that a business loan can be invaluable.
If you take out a loan to get your company started, your company’s access to credit will depend on your personal access. In either case, everything starts with having a solid personal credit score.
Credit helps you avoid payday lenders
Having a high credit score can help you avoid predatory lenders that overcharge for short-term loans. Payday loans or cash advance loans are some of the most expensive ways to access quick cash, but for people without a strong credit history, these may seem like the only option.
These lenders are popular because they don’t rely on your credit score, just the value of your next paycheck. This also means they’re not looking at your other expenses or considering how hard it might be for you to repay in a few short weeks. If you miss a payment on a payday loan, which is very likely, the late fees are incredibly high, and you can get stuck in a cycle of debt it’s hard to climb out of.
Access to credit means you can use credit cards on large or emergency purchases instead of relying on a payday loan provider. The Consumer Financial Protection Bureau found that typical payday loans charge a fee of $10 to $30 for every $100 borrowed. A typical $15 per $100 borrowed for a two-week loan will equal an annual percentage rate (APR) of 400%. In comparison, even the credit cards with the highest APRs of 30% are still a far better deal for the borrower.
Key takeaways
Why is credit so crucial to your financial future? Because it determines the rate at which you can borrow money.
These interest rates are essential to keep an eye on as you build your financial stability. Interest rates vary based on the credit type and your score. As of March 2023, the average interest rates are as follows:
- Mortgages: 5-7% Interest Rate (Source)
- Credit cards: 18-27% APR (Source)
- Auto loans: 5-20% APR (Source)
- Payday loans: Averages $10 – $30 per every $100 borrowed, equaling nearly 400% APR
Esusu renters have gone on to establish thousands of credit scores and access credit cards, student loans, car loans, and even home mortgages.
We’re announcing exciting new tools for Esusu renters in the coming weeks. Stay tuned for emails from us about how you can monitor and grow your score during Financial Literacy Month and beyond! If you’re not an Esusu renter, you can stay up-to-date on finance tips by following us on Instagram and Facebook.
Esusu is not affiliated with any of the companies mentioned, and the information provided through these links is for informational purposes only.