From car loans to home mortgages, a borrower’s credit score and credit history have a direct bearing on the interest rate they are charged. The difference between excellent credit and even good credit can mean thousands of dollars in interest payments over the life of a home loan. And the same is true with credit cards.
Known as risk-based pricing, credit card issuers continue to offer better interest rates and even better rewards to those applicant’s with excellent or good credit ratings. Card issuers even offer significantly different terms on the same branded card based on an applicant’s credit. As a result, some card issuers have made an effort to disclose just what “excellent,” “good,” or other credit ratings mean.
Card issuers do not typically disclose these credit ratings in terms of credit score. Instead, the ratings are defined based on such factors as payment history, open credit accounts, history of bankruptcy and the like. Card issuers have also sought to disclose how the terms of their credit cards vary based on these credit ratings. With this information, a consumer looking to apply for a credit card can obtain some understanding of their credit rating and how it will impact the type of credit card they can obtain.
Credit Ratings
Several credit card issuers provide guidance on what it means to have excellent, fair, or even bad credit. For example, Discover Card categorizes an applicant’s credit into one of three categories: excellent, fair, and needs improvement. Here’s how Discover defines each:
Excellent Credit: You are considered to have Excellent Credit if you pay all your bills on time and never miss payments.
Average Credit: You are considered to have Average Credit if you pay most of your bills on time, and have made one or two late payments (more than 30 days past due) in the last year.
Needs Improvement: Your credit Needs Improvement if you pay your bills, but have made three or more late payments (more than 30 days past due) within the past two years. Capital One takes a similar approach, but classifies an applicant’s credit rating into four categories: Excellent, Good, Average, or Limited History.
Here is how Capital One defines each of these ratings:
Excellent Credit
- You have had a loan or credit card for at least five years
- You have a credit card with a credit limit greater than $10,000
- You have never been more than 60 days late on a credit card, medical bill or loan payment
- You have never declared bankruptcy
Good Credit
- You have had a loan or credit card for three years or more
- You have had a credit card with a credit limit above $5,000
- You have not been more than 60 days late on any credit card, medical bill, or loan in the last year
Average Credit
- You currently have or have had a U.S. loan or credit card
- Your credit limit on a current credit card, if any, is less than $5,000
- You may have been late on more than one credit card, medical bill, or loan payment in the last six months
Limited History
- You have had my own credit card for less than three years or never had one
- You have a limited credit history, for example I am a student, or new to the country, or a young person working for a living, or I have been an authorized user on someone else’s credit card
- You have a valid credit score that can be found at one of the major credit reporting companies
With these descriptions, a credit card applicant can get a rough idea of how their credit history would be viewed by credit card issuers.
Translating Credit Ratings into Credit Card Terms
Depending on your credit rating, the terms offered on major credit cards can vary significantly. The popular Discover More Card provides a good example. Recall that Discover uses three credit ratings for its applicants: Excellent, Average, and Needs Improvement.
For those with excellent credit, Discover currently offers a variable APR as low as 10.99%. With average credit, the variable rate is currently as low as 12.99%. And with credit that Discover classifies as needing improvement, the interest rate jumps to a current rate of 18.99%. Thus, depending on an applicant’s credit rating, the interest rate charged on the same credit card can nearly double.
Capital One cards likewise vary the interest rate based on credit history. The popular No Hassle Miles Rewards card, for example, currently comes with a 13.9% variable interest rate for those with excellent credit. If you have “good” credit, however, the rate goes up to 16.9%.
Interest rates are not the only terms affected by an applicant’s credit rating. Credit card companies are now also offering longer 0% balance transfer offers and richer rewards for those with excellent credit. For example, the Discover More card comes with a 0% balance transfer feature. For those with excellent credit, the 0% introductory rate is good for 9 months. But it lasts only 6 months for those with good credit or credit that needs improvement.
The Capital One Platinum card likewise offers a no interest balance transfer feature that varies based on an applicant’s credit. For excellent and good credit, the card offers a 12-month balance transfer. For average credit and below, the card does not offer any balance transfer.
Travel rewards can also vary based on an applicant’s credit. The Capital One No Hassle Miles Reward card, for example, pays out differing miles based on credit. For those with excellent credit, the card pays 2 miles for every dollar of monthly spending above $1,000, and 1% on the first $1,000. With good credit, however, the card pays out a flat rate of 1.25 miles per monthly dollar spent. And below good credit, the card is not available.
Risk-Based Pricing
Applying different card terms to applicants with different credit ratings is known as risk-based pricing. The practice has received a lot of attention lately, particularly when risk-based pricing is applied to current cardholders. For card applicants, however, risk-based pricing of card terms will undoubtedly continue, and represents another reason why protecting your credit is so important.
This is a guest post written by Rob B., Managing Editor of Credit Card Offers IQ, a website focused on evaluating the best consumer and small business credit card offers. Rob writes frequently for the site’s credit card blog, as well as for a variety of personal finance and investing websites.
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