When Saving Can Actually Hurt You

Americans are nudging up their savings rates and getting more careful about borrowing.

This begs a question: If you have some spare cash, should you save it or use it to improve your credit score?

Saving and investing have obvious benefits, providing an emergency reserve for the present and a nest egg for the future. But spending money to improve a credit score can produce long-term benefits, too, making it cheaper and easier to borrow for a car, home or other need.

Saving should probably be your top priority if you do not already have a rainy day fund to deal with a lost job, leaky roof or blown furnace. Most experts say an emergency fund should equal three to six months’ salary.

Once the fund is full, the choices get trickier.

Start by getting your FICO score from the company that produces it, the Fair Isaac Corporation (Stock Quote: FIC) or any of the other suppliers you can find by typing “FICO Score” into your search engine.

Scores range from 300 to 850. Scores over 720 are considered excellent, while those from the high 600s to 720 are good enough to get you most loans, but probably not at the lowest interest rates. It gets harder and harder to borrow as your score falls below the mid 600s.

In an example from Fair Isaac, an applicant with an adequate income and a score of 760 to 850 should be able to get a 30-year fixed-rate mortgage charging 4.67%. With a score of 620 to 639, the same borrower would have to pay 6.259%.

Monthly payments on a $300,000 loan would be $1,551 for the first borrower and $1,849 for the second, a $298 difference that demonstrates the value of having a high score.

A borrower’s payment history is the most important of the five factors determining a score, counting for 35% of the total. Making payments on time should be a higher priority than either saving or building a rainy-day fund. Paying on time will save you the late fees as well as improve your credit score.