You’re probably well aware of what a credit score is, but what exactly determines your overall credit, and how does it benefit you? Your credit plays a role in your purchasing power in a number of ways. This article will cover credit and purchasing power in depth, as well as how they intersect in crucial ways. Plus, we’ll reveal top tips along the way to improve your financial wellness overall.
What is Consumer Purchasing Power?
At its simplest, consumer purchasing power is the ability for people to buy the goods and services they want and need. The current monetary value and inflation both factor into the measurement of purchasing power.
In general, if your income goes up at the same rate that prices do, your standard of living remains the same. If your income rises more quickly than costs, then your standard of living improves. If the opposite happens, then the standard of living decreases. This illustrates the range of possibilities of someone’s buying power.
In 1921, the United States government began to track what’s known as the Cost of Living Index. This index measures consumer purchasing power and the cost of living by monitoring the prices of 400 items. During the first several years of its existence (1922-1928), consumer purchasing power rose. During the next decade (the Great Depression), the country’s buying power dropped.
Buying power plays a key role when someone is looking to purchase on credit—whether they plan to apply for a mortgage, a car loan, or a credit card. Said another way, buying power involves someone’s ability to get funding approved for new debt. When they have significant ability to do so, they have high buying power.
Why Purchasing Power Matters
People often have conversations about consumer buying power, but they don’t usually use that specific term. Perhaps when they discuss how the prices of bread, milk, and eggs have gone up at the grocery store—or when they’re car shopping and thinking that they might not be able to afford a new car right now. In both cases, they’d be talking about a reduction in purchasing power.
If you’ve saved money and prices have gone up due to inflation, then the power of those saved dollars aren’t as strong as they once were. So, if you find yourself saying, “Money just isn’t going as far as it used to,” you’re talking about a reduction in purchasing power. The same concept applies when you look at the balance in retirement accounts or other investments.
Now, we’ll switch gears to the second part of the topic: What is a credit score, and what is a good credit score?
What is a Credit Score?
A credit score is a three-digit number derived from someone’s credit report—and a credit report is a compilation of a person’s credit history, including a listing of debts
, their outstanding balances, timeliness of payments made, and so forth. The purpose of the credit score is to give lenders a quick snapshot of how likely you’ll be to make payments on time based on past credit history.
It's up to lenders, banks, credit card issues, collection agencies, and other entities to decide which financial information about you they report to one or more of the credit bureaus, such as Equifax®, Experian® and TransUnion®, that end up on your credit reports. Because there are so many different credit-scoring models that have their own formulas for how they weigh certain credit factors from these reports, you'll have multiple credit scores that vary among apps and lenders, depending on which model they use. You can see your credit reports with each of these bureaus at AnnualCreditReport.com
at no cost to you once per year.
A credit score ranges between 300 and 850 with a higher score resulting in a better chance for loan approval, better loan rates, and more. FICO®
is a credit score often used by financial institutions when making lending decisions.
Factors that go into its calculation are as follows:
- Payment history (35%): Paying bills on time is the biggest factor in establishing and maintaining good credit scores. The opposite is also true with late and missed payments damaging scores.
- Amount owed (30%): This includes the credit utilization score. If you add up all the money you owe on consumer loans (such as credit cards and personal loans) and then divide that amount by the total limit available, the resulting percentage demonstrates your credit utilization – and would ideally be less than 30%.
- Credit history length (15%): Overall, having a longer credit history is better (but it’s not absolutely necessary). This is why you should consider keeping a credit card open even if you don’t actively use it and it’s paid off.
- Credit mix (10%): Having a mixture of installment loans (such as personal loans, car loans, and student loans) with revolving credit (such as a credit card) can demonstrate to lenders that you can manage both types.
- New credit (10%): Applying for too many credit accounts quickly can ding your credit scores, especially if you’re still in the process of building a good history. If you have too many new accounts, this will lower your credit history mix.
The FICO score is calculated from these five factors, but its credit-scoring model changes regularly and different factors are weighted differently for certain types of lenders, so your FICO scores may differ. Lending institutions make a decision based in part on this score. When you become a Space Coast Credit Union (SCCU) member, you can check your FICO score for free
What is the Difference Between a Hard Pull and a Soft Pull?
A lender may conduct a hard inquiry (hard pull/hard credit check) or a soft one. A hard inquiry usually results in a decision to offer, or not offer, a loan or other type of credit. A hard pull will show up on your credit report as a new application for credit. One hard inquiry may not have an impact on your scores, but several could. A lender could perceive that a borrower needs to get new loans to juggle their finances.
A soft inquiry (soft pull/soft credit check) is when a lender is investigating a person’s credit, but it’s not necessarily in response to an application for credit. In this case, the credit checks won’t have an impact on credit scores and may not even show up on credit reports.
What is a Good Credit Score?
Sticking with FICO, here’s the breakdown of credit score category ratings:
- Exceptional: 800-850
- Very Good: 740-799
- Good: 670-739
- Fair: 580-669
- Poor: 300-579
Lenders often have their own guidelines, including on the minimum score a borrower needs for loan approval. So, although FICO labels scores between 670-739 as “good,” lenders may use somewhat different numbers to qualify borrowers. In most cases, the better the credit score, the better the interest rate offered.
Building Good Credit
Initially, building a good credit score can feel like a real catch-22. Borrowers need to demonstrate good credit scores to open accounts that can help build good credit scores. SCCU offers a variety of ways to help members navigate this endeavor:
- Student credit cards: Students between the ages of 15-18 can obtain a student credit card as long as a parent or legal guardian is also on the secured account. This account starts with a low line of credit and can increase with a history of responsible usage. Paying this credit card on time and managing it well can help a student build good credit.
- Secured credit cards: If you’re looking for a low-risk way to build or improve your score in a timely manner, a secured credit card is a smart choice. It requires a minimum deposit and uses your savings account as collateral, with the possibility of raising your credit line to a maximum amount. Again, paying this on time can go a long way in establishing good credit.
- Cosigned account: Having someone with established good credit cosign on a credit card or loan often leads to lender approval. By making payments on time, the borrower can build good credit with the goal of going solo in the future.
Here’s more information about building credit scores
and here’s a helpful credit score worksheet
How Purchasing Power Improves with Good Credit Scores
When you have excellent credit, it leads to better buying power. Because with quality credit, you’re more likely to get better interest rates on loans. Plus, you’ll also have a better chance of getting approved for higher loan amounts. Borrowers with poor credit may get approval for a loan with the caveat of higher interest rates.
Additionally, with good credit, you’re more likely to get approved for a lower deposit if you’re renting an apartment as well as lower insurance policy premiums. Both of these benefits mean you’ll be able to save more money for larger purchases and stay on top of loan payments.
Getting a raise or bonus at work or otherwise increasing your income can help with purchasing power, too. After all, more financial resources at hand allow you to buy what you want and need, and it makes it easier to save money for down payments on houses, cars, and the like. When you put down more money up front, you can borrow less and pay less interest over the life of the loan. When you pay less interest, you pocket more savings.