One of the most common topics regarding personal finance is the credit score. There is an obsession in our culture about having a good credit score which isn’t a bad thing in itself. The problem though is that what gives you a good credit score is not what is best for you overall. So many people get caught up in trying to have a good credit score that it hurts them the rest of their financial life. So, here is why you should ignore your credit score if you want to be good with money.
What Is A Credit Score
A credit score is a number that predicts how likely you are to repay a loan. If you have a credit score, it ranges from 300 – 850 with 850 being perfect. There are 6 ranges within that spread that will qualify how good your score is.
These ranges are:
- 800–850 Excellent
- 750-799 Very Good
- 700-749 Good
- 650-699 Fair
- 600-649 Poor
- 300-599 Very Bad
So, if you have a credit score, and anyone who borrows or takes out a loan will have a credit score, you want it to be good if not very good or excellent.
It is also known as a FICO score although there are multiple agencies that can report your credit, but FICO is the most commonly known.
Why Is A Credit Score Important
A credit score is important because if you are going to borrow, like taking out a mortgage or getting a car loan, your interest rate that you receive will be based on that score. As I said earlier, the lender needs to know how likely you are to pay the loan back to protect themselves. As a result, they check your credit score.
If they feel that you are likely to pay it in full then you can get a lower interest rate since they think you won’t stop making payments before it is fully paid off.
A lower score will result in a higher interest rate since they feel you are more likely to not pay in full. Therefore, they charge you a higher interest rate to help make up for potential losses.
This only matters if you plan to take out a loan in the future. It doesn’t affect past loans or debt you might have.
Now, there are instances where you can take out a loan if you don’t have any credit at all (technically a score of 0). To do this you can have a loan manually underwritten such as a mortgage. You can’t do that if you have a low score though.
How The Credit Score Is Calculated
Essentially, your experience and history with debt is what determines your score. Below is the breakdown of the factors that make up your score.
- Your payment history (35%)
- The amount of debt you owe (30%)
- The length of your credit history (15%)
- Hard inquiries on your credit report (10%)
- Your credit mix or types of credit you have borrowed (10%)
All of this adds up to one score that will fall in the range mentioned earlier. Note that the credit mix, while not a big part of your score, wants you to have multiple types of credit. This includes a mortgage, car loan, student loans, credits cards, etc.
It is very common for people to be up to their eyeballs in debt and have a good credit score. The credit score is not the sole determining factor regarding your financial situation. It gets billed that way, so each time someone says they have good credit please keep in mind that says nothing about their current financial standing.
What Isn’t Included In Your Credit Score
Now, before we go further, think about what isn’t included. What do you think would be a good predictor of whether someone will pay back a loan in full?
It might include those points above, but what about these points.
- The amount of money you have in the bank
- Net worth
- Income level
- Stability of your job
- Your monthly budget
- Your ability to pay cash for something outright
- Amount of insurance coverage
I am not saying all of these should be a part of your score, but these are all things that would affect your ability to pay off a loan when things go wrong. If you lose your job, can you keep paying the loan? If you get sick, do you have adequate insurance to cover the sickness so you can keep making your loan payments?
Regarding your income, it is not a part of your credit score, but the lender does factor it into whether you get approved for a loan.
Also, can we say it is dumb for inquiries to negatively affect your credit score? This is the system that was set up, yet when you use it, you get dinged?
Why You Should Ignore Your Credit Score If You Want More Money
Now that we know about what the credit score does, let’s be honest about what it really is doing. It might seem like it is gauging your ability to pay off a loan, but it is really keeping you in a system that promotes debt.
If you are reader of Debt Free Happens, then most likely, you have been burned by debt and are ready to be done with it. The problem is that credit scores don’t promote being debt free. They promote having all types of debt that you pay back each month.
Sure, it rewards you if you make your payments on time and keep your balances low, but there is no freedom in making monthly payments.
This site is called Debt Free Happens because I want each one of you to know it is possible to be debt free. I also want you to move on past debt and find financial independence. All these debt payments that you might keep around to help a credit score get in the way of that independence.
Side Note: Don’t completely ignore it. If there has been a data breach then you can freeze your credit. If you pay off a debt that still shows up negatively on your credit report then contact the company to have it removed. The point is that I want you to ignore the process to getting a good score for the sake of a good score.
What You Should Focus On
Instead of asking “how do I improve my credit score,” you should really be asking “how can I pay off this debt?”
You should focus on paying off your debt and putting yourself in a strong financial situation so that you don’t have to take out loans in the future. You need to put yourself in a spot where interest rates don’t matter because you pay cash for everything.
Just because you have a good credit score does not mean that your debt isn’t a problem. It is. In fact, it is an emergency!
So, who cares if it hurts your credit score if you don’t have a variety of loan types? You want to have money in the bank to insure yourself when something goes bad.
How This Affects Your Money
Let’s look at how this might play out in your life to see where you can improve your financial standing.
When looking at car loans it is common for people to have car loans their entire life. It is just a known thing that you will always have a car loan which does not have to be the case. When they get close to paying it off they go and get another one. They feel it is easier to make the payment than pay in full for it.
The problem is that you are always paying interest on that car loan over your whole lifetime. Why not pay cash for a car, whatever you can afford, and then take the money saved in interest and invest it? We are talking a difference of thousands and thousands of dollars.
Also, always keeping a credit card balance, no matter how low will cost you so much over your lifetime as well.
You need to be making money off your money and not let someone else profit from your money!
Once you start operating from a position of cash you think twice about how you spend your money. You find that you can take advantage of better opportunities as well so there are lots of benefits to not always carrying debt.
Future Changes To Credit Scores
Recently FICO made an announcement that it is looking to change how it evaluates your credit. Maybe this will be a better representation of your ability to pay off a loan, but you need to still focus on paying off your debt. Don’t get caught up trying to play the credit score game.
What Happens To Your Credit Score When You Pay Off Your Debt
So, technically, your score goes down a bit when you ditch all your non-mortgage credit. The funny thing though is that while focusing on getting out of debt and not keeping it around will help your credit score in the long run.
Getting rid of car loans, student loans and credits cards will help your financial picture tremendously, but it doesn’t mean you can’t have a good credit score if you ditch those.
Since we have a mortgage and pay off our credit cards every month, we have a credit score so here is a snapshot of ours. The big ding we get is that we don’t have enough of a variety of debt. You know what though, we are doing just fine without all that debt around anymore.
As you can see my score is 808. The funny thing is that when Erin and I got married, I had way more debt than her and was much worse with money yet my score was better. She was not happy about that, but it showed how wrong the system is. She was better with her money, yet I had the higher score. That was not positive reinforcement for me to change.
Your Next Steps
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