Your credit score gives lenders a sense of how likely you are to pay back what you owe, meaning it's a reflection of your creditworthiness. The three major credit bureaus (Experian, Equifax, and TransUnion) calculate your credit score by taking into account a number of factors, like your payment history and how long you have been using credit responsibly.
When you take steps to increase your credit score, like paying your monthly bill on time, your goal is "to go from a higher-risk to a lower-risk borrower," Tendayi Kapfidze, chief economist at LendingTree, told Grow earlier this year.
The higher your credit score, the better your chance of qualifying for the best terms on a loan. And even relatively small differences in your score "can add up to to thousands of dollars in savings over the life of a loan, and hundreds in savings on the monthly payment," says Kapfidze.
Based on most models, credit is scored on a range from 300 to 850, with most people scoring between 600 and 750. That range is broken down into five categories, from "very poor" for the lowest numbers to "exceptional" at the top of the range.
Each category gives lenders a sense of your risk as a borrower, and one way to reduce this risk is to bring your credit score up to the next level. That means, if you have "fair" credit (580-669) and you boost your score to 670 or higher, you would fall in the "good" range and, as a lower-risk borrower, qualify for lower rates — and save a lot of money.
Here's how taking small steps to push your credit score to the next range can lead to big savings.
"Your credit score basically grades how likely you are to pay back what you owe," says Matt Schulz, chief credit analyst at LendingTree. "If you've shown that you can handle the responsibility in the past, lenders are much more likely to help you out in the future."
Understanding how far you are from the cusp of the next scoring range can help you make decisions about your credit. If you're close to the threshold — you have a "fair" score of 650, for example — it's worth boosting your score 20 basis points to 670 so you'll be in the "good" range before you applying for a loan or credit card.
Let's say you owe $5,000 on a credit card with a 24% APR, a fairly typical APR for those with "fair" or "poor" credit. If you put $250 per month toward your debt, it will take you 26 months to pay off the balance, and you would pay $1,449 in interest overall.
But if your credit score falls in the "good" range or above, you're more likely to get a lower APR: "If you drop that APR to 19% and leave everything else the same, the borrower will pay just $1,060 in interest and will knock a month off of the above payoff time," Schulz explains.
"When it comes to credit, banks are all about managing risk," says Schulz. "The risk we're talking about is the possibility that the borrower might not be able to pay the bank back what it borrowed."
Becoming a lower-risk borrower can also help when you're applying for a mortgage. If you're applying for a mortgage, a score of 760 or higher will typically get you the best rates. And though you can qualify for a home loan with a score as low as 620, your interest rate will be higher than a homebuyer with a great score, and you could end up paying tens of thousands of dollars more over the life of the loan.
Video by David Fang
To get "very good" credit, which FICO defines as a score of 740 or higher, these are the most important things you can do, according to experts.
There other small ways to boost your credit, too. Bobby Berk, one of the stars of the hit Netflix show "Queer Eye," improved his credit score by nearly 150 points by paying off his statement a few days before it was due. Because many score formulas use the balance on your last statement to calculate your credit utilization, your score could drop if you have a high balance when your billing cycle closes — even if you pay off your balance in full just a few days later.
In Berk's case, his statement closed on the 30th of the month, so he set a reminder on his phone to pay off the balance on the 28th. Then "I watched my score go from the low 700s to 840 or 845," the interior designer told Grow last week.
As you work to improve your credit, remember that every little bit helps: "Crummy credit is really expensive, so every step you take up the ladder can end up saving you money," says Schulz.
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