Don’t Ignore Your Credit Score
Anti-debt guru Dave Ramsey is the introductory point to personal finance for many people. His one size fits all rules provide the simplicity needed to dig themselves out of debt. His recommendation to completely avoid credit can be a reasonable approach until you learn to use it responsibly.
Most of us can use credit responsibly once we build a solid financial foundation. Even if you don’t ever want or need to borrow money, ignoring your credit score can be detrimental in numerous ways.
As an example, I recently spoke to a couple who followed Ramsey’s advice when deep in debt. They are now millionaires with a paid off home, successful business, and high savings rate. Yet when they applied for a travel credit card to earn some rewards and make booking travel easier and secure than using a debit card, they were denied due to a lack of credit history.
I asked one of my Abundo Wealth colleagues and credit expert DJ Jack to share why paying attention to your credit score matters and what you can do to rebuild it if you’ve avoided credit for years. Take it away DJ….
The Credit Paradox
Imagine this paradox. High net worth individuals, boasting portfolios with millions of dollars, find themselves at the doors of financial institutions only to discover that their access to credit is barricaded—not by lack of funds, but by a lack of recent credit history.
This scenario underscores a crucial financial nuance. Regardless of your income or assets, a good credit score is an indispensable tool in your financial toolkit. It’s about more than just borrowing money; it’s about optimizing your financial well-being.
From securing loans with favorable rates to unlocking the best travel credit cards that come with a suite of benefits, a robust credit score is a gateway to a plethora of financial advantages. On the flip side, the absence of a credit score or a low score can be a silent hindrance. It raises unseen barriers to opportunities and conveniences that many take for granted.
In this article, we’ll demystify the concept of credit scores for high net worth individuals who find themselves on the outskirts of the credit world, looking in. We’ll explore the tangible benefits of maintaining a good credit score, the drawbacks of neglecting this aspect of your financial identity, and provide a roadmap for building or rebuilding your credit history.
The Importance of a Good Credit Score
At its core, a credit score is a numerical representation of your creditworthiness. It distills your credit history into a score that ranges from 300 to 850. It is the result of an algorithm that takes into account various factors, including:
- your payment history,
- the amounts you owe compared to the amount you have available,
- the length of your credit history,
- new credit accounts,
- and the types of credit you use.
It might seem like just another number. But implications stretch far and wide, influencing several aspects of your financial life.
Upsides of a Good Credit Score
1. Lower Interest Rates on Loans and Mortgages
A high credit score is often the golden ticket to securing loans and mortgages at the most competitive interest rates. Lenders view a high score as a sign of financial reliability. They reward you with lower costs over the life of your loans.
2. Credit Card Approvals
Ever wondered how some individuals have access to credit cards with the most lucrative rewards, including travel perks, cash back, and exclusive offers? A solid credit score is key. Financial institutions reserve their best offers for those they trust the most. They express this through your credit score.
3. Higher Credit Limits
A higher credit score can unlock higher borrowing limits. This gives you greater financial flexibility. More available credit also can help manage your credit utilization ratio, a crucial factor in determining your credit score.
4. Rental and Housing Opportunities
Many landlords now check credit scores as part of the rental application process. A good credit score can make the difference between securing your dream apartment and being turned down for a lease.
Drawbacks of a Low Credit Score
1. Higher Insurance Premiums
It’s not just lenders who take an interest in your credit score. Insurance companies often use it to set premiums for auto and homeowners insurance, with lower scores leading to higher premiums.
2. Security Deposits on Utilities
A low credit score might mean you have to pay a security deposit when setting up utilities in your name. While refundable, these deposits can be an unnecessary inconvenience and expense.
3. Challenges in Financial Flexibility
A substandard credit score limits your financial flexibility. You’ll find it harder to secure loans, get approved for credit cards, or even pass certain employment checks.
In essence, a good credit score opens doors, both literally and figuratively, in the financial realm. It’s about enabling opportunities and minimizing costs, ensuring that your financial path is as smooth and advantageous as possible.
Understanding its importance is the first step. The next step is learning how to build or rebuild your credit score to harness these benefits fully.
Strategies to Build or Improve Your Credit Score
Building or improving your credit score can feel complex, especially for those who have prioritized a cash-only lifestyle or find themselves with a sparse financial history. However, the path to establishing a solid credit foundation is more straightforward than it might seem.
Assuming you don’t have any negative credit history working against you, you shouldn’t have any trouble being approved for your first basic credit card. If you’re eager to accelerate your journey towards an exceptional credit profile, consider employing one or more of the following strategies.
Report Alternate Payments
Traditionally, rent and utility payments aren’t reported to credit bureaus. However, services such as Experian Boost, Self, and RentReporters now allow you to get these payments recognized towards your credit score.
Enrolling in a service that reports your timely rent and utility payments can be an easy way to build credit without going into debt.
Secured Credit Cards
A secured credit card is a fantastic entry point into the world of credit for those who might not qualify for traditional credit cards. Unlike standard credit cards, a secured card requires a cash deposit that serves as your credit limit.
This deposit acts as collateral for the issuer. It reduces their risk and makes it easier for individuals with little to no credit history to get approved. Use this card for regular purchases and pay off the balance in full each month. This demonstrates responsible credit use and can help build your credit score over time.
Credit Builder Loans
Credit builder loans are designed specifically for people looking to build or rebuild their credit. Unlike traditional loans, with a credit builder loan, the amount you borrow is held by the lender in a bank account while you make payments.
Only after the loan is fully paid off do you get access to the money. These payments are reported to credit bureaus, thereby helping to establish a history of on-time payments.
Become an Authorized User
Having a family member or friend add you as an authorized user on their credit card can be a swift way to piggyback on their credit history. If the primary cardholder has a long history of responsible credit usage and pays their bills on time, this positive credit behavior can be reflected on your credit report too. Just ensure the credit card issuer reports authorized user activities to the credit bureaus.
Diversify Your Credit
A mix of credit types can positively affect your credit score. It indicates to lenders that you can manage different types of credit responsibly.
Once you’ve established a good foundation with a secured card or a credit builder loan, consider diversifying your credit. This could include taking on a retail credit card, an auto loan, or a personal loan, as long as these are managed wisely, terms make sense, and payments are made on time.
Building an excellent credit score hinges on consistent responsible financial behavior. The key is to approach this process with the same discipline that guided you towards financial stability in the first place.
Ensure that any spending on credit remains well within your means. Prioritize making all payments promptly by the due dates.
Conclusion
For individuals who have lived a life avoiding credit, moving from a cash-centric philosophy to a more credit-inclusive approach can be a major shift in your financial identity. This shift is essential for leveraging the complete range of financial tools available today. Managed wisely, your credit score unlocks opportunities that can enrich your life and enhance your financial well-being.
Your Experiences With Rebuilding Credit
Thank you DJ for sharing these perspectives and ideas!
It amazes me how many people I’ve encountered who are otherwise doing incredibly well financially, who run into issues due to a poor credit score. These issues are usually discovered when they apply for a credit card, mortgage, or other loan. They are surprised to get rejected or receive unfavorable terms.
I’m curious how many readers of the blog have encountered this issue. Do you monitor your credit score? Have you had success building or rebuilding your credit score with techniques DJ recommended? Have you used other techniques?
Share your experiences in the comments below.
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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. After achieving financial independence, Chris began writing about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. Chris also does financial planning with individuals and couples at Abundo Wealth, a low-cost, advice-only financial planning firm with the mission of making quality financial advice available to populations for whom it was previously inaccessible. Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He has spoken at events including the Bogleheads and the American Institute of Certified Public Accountants annual conferences. Blog inquiries can be sent to chris@caniretireyet.com. Financial planning inquiries can be sent to chris@abundowealth.com]
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It always amazes me when people try to poke holes in Dave Ramey’s baby step program. They usually look at credit scores and the downsides to not having one.
Dave himself will tell you there are some, but not qualifying for CC is not one of them. Afterall, as you pointed out, this person is worth well over a million dollars and now wants a CC for some travel rewards. Like this will make a difference in their financial life. If it does, they start from scratch like everyone else and build their credit. It just takes time. This clearly wasn’t their priority while building wealth.
Among those downsides are
– Renting is more difficult. But you can usually leave a larger deposit in many cases. Or continue to look.
– Insurance is sometimes more expensive at 1st as there are studies that show those with low or no credit score to have more claims. After 2 or 3 years, your rates are based on your record.
Some employers pull your credit report looking for negative remarks, not credit scores. People often claim that not having a credit report will hurt you, but that is false.
The upside though is people build wealth. And often a lot of it. You almost can’t help yourself. And people have no idea since you live in a smaller house and drive used cars.
We’ve been following Dave’s plan since 2005. We put three kids thru college debt free; have a high net worth; no debt; and looking forward to retirement. Now that the kids are out of school and on their own, we travel a lot with our friends. (who are also debt free). I’m seeing a pattern…
Outside a mortgage, debt is truly avoidable. People don’t like living that way for two reasons:
1. They have been taught that debt is normal.
2. They are afraid to solely rely on themselves. Debt is a crutch that is east to lean on and tough to get rid of.
Scott,
I think Dave Ramsey is exactly what many people who are deep in debt need. Simplicity. Behavioral finance. Actionable steps. Occasionally some tough love.
I don’t attack anyone who is genuinely helping people. However, I do challenge people to continue to learn and not blindly follow anyone as their “guru.”
Beyond getting out of debt I think a lot of what Ramsey says is simply flat our wrong. His investing advice leads people to commissions based salesman who are likely to push expensive investments that will likely underperform, when learning the basics of a low cost, tax-efficient investment approach is just not that hard.
I’ve recently shared his rant on retirement withdrawal rates which was mathematically wrong. Worse, he shows he isn’t able to even consider he may be wrong and insults anyone who dares disagree with him and point that fact out, including members of his own team to whom he is publicly verbally abusive.
I tend to mostly agree with you (and Ramsey) in being anti-debt. However, I do think it is worth learning the rules of the system we operate in and building and maintaining a credit score. It’s not hard and it doesn’t require paying interest to lenders. We’ve managed to go through life without ever having a car loan, paying our mortgage off quickly, never paying interest payments to CC companies, etc. while simultaneously building, maintaining, and benefitting from an excellent credit score. This doesn’t have to be an all or none proposition.
Best wishes,
Chris
Hey, Chris
I seldom answer to any person ‘attacks’ on others, but I have to take this one as an exception. Your “mild-mannered” attack on other people who are trying to help others is what I am taking you to task. First and most important is that I am not a ‘disciple’ of Ramsey. I got out of debt when Jimmy Carter had interest rate at upwards of 20+%. I can testified that debt-free is the key to FI with peace of mind & investment snow-ball.
There is a reason it is called Personal Finances because it is very PERSONAL. You may not like any body’s else approach but you have no rights to attack another, considering the fact that you take other people’s money called advisor’s fee(s) while Ramsey, others like him, doesn’t.
In conclusion, it is also very personal to each one and has to tailor to each one. Sometimes honest answers are hard to take, like a parent tries to make sense to his child.
I have enjoyed reading some of your stuff and a few of them are helpful & I have tried to learn something from everybody. Mild-mannered or not abusive attack on others has no place in this kind of discussions. Please let us stick to finances and not attacking others.
Thank you.
I think Dave Ramsey is great, really great, for all the reasons that you guys have already said. Just be aware, that when you state well-reasoned disagreements with parts of what he advocates, you are playing into his very successful media empire-building strategy of “creating buzz”. Particularly in our world, controversy is buzz. The best way to get people to pay attention to Dave, and tune in, and get into his media empire is to state your disagreements with him. If you agree with him and say so, no one will go any further than that. If you “create buzz” for him, people will be driven to go find out what the controversy is all about. It’s like the old Hollywood maxim that, “there is no such thing as BAD publicity.”
Art and Box of Rain,
I know you guys are coming at this from opposite perspectives, but I just don’t see where there is anything in this article that is attacking anyone. Disagreeing with someone’s philosophy or pointing out that certain practices can have both positive and negative consequences simultaneously is not the same as a personal attack. I’m not sure where this thread of the comments kind of went off the rails, but I really don’t have anything more to add to this.
Best wishes,
Chris
My husband and I have been completely debt-free for many years and have wondered about this question, so I read this article with a great deal of interest. None of the reasons why credit scores matter, discussed in this article, apply to us: it is extremely unlikely that we will ever apply for a loan again, we have all the credit cards we need or want (and pay them off every month), we no longer have utility or other deposits, and our insurance rates are reasonable (maybe because we have been with the same insurer for more than twenty years). I do check with our credit scores a couple of times a year (and while our scores are excellent, they are not perfect) but wonder why I bother. I’m curious about others’ thoughts and experiences.
We’re in the same situation for the most part except for a couple of situations where I decided to go through some hassle to make some extra $:
1) I play credit card promo games. When bored, I’ll sign up for 60k+ bonus points on various cards, having each spouse apply separately. I guess you see it as a hassle not worth playing
2) When buying our new car, got a 2.99% rate. So I put the full balance of the loan in a Fidelity money market account with autopay linked to that account. I’m getting 4.99% in interst and paying 2.99% in financing. I’ll continue to make money on the interest spread until MM rates fall and I can’t profit anymore. At that point, I’ll pay off the balance from that same MM account.
Thanks for your comments, Phillip. Those are both good strategies; you’re right, we haven’t used them, telling ourselves that we favor simplicity over saving a few bucks, but it might just be laziness. Your comment was a good wake up call.
Elizabeth,
Your credit score doesn’t need to be perfect. If you have an excellent credit score and simply continue doing what you’re doing you’ll be fine. This article was to address a scenario I’ve encountered multiple times of people who are otherwise doing well financially, but have a poor or no credit score.
Phillip,
Thanks for the thoughtful comment. I’m with you and I want to be clear that we’re not advocating for thoughtless use of debt. I’m simply saying that you should pay attention to maintaining your credit score because there are benefits such as qualifying for the best credit cards, getting favorable loan terms, etc. that at times can make life easier or help you build wealth.
Best,
Chris
Elizabeth, I’m an optimistic, but realistic, person. Life can change in an instant, and we’re all potentially one step away from a tragedy (an unexpected death, a disastrous fire, a disabling auto accident) or an amazing opportunity (the trip of a lifetime, a dream home becoming available two miles from the kids and grandkids). Even though my husband and I are debt-free and financially secure and don’t expect to need credit in the future, we guard our credit scores diligently. Our philosophy is that it’s better to have and not need than need and not have.
Well said Mary. Thanks for chiming in!
Early this year, AARP published an article written by George Mannes, one of the organization’s executive editors (and formerly with Money magazine) that detailed his efforts to deliberately ruin his credit to determine how certain actions (or inaction) would impact a credit score. Over the course of the project, his credit score dropped from 826 to 697. Using a credit score simulator on FICO’s website, he determined that he could increase his credit score up to 749 in two years if he spent normally and made all his payments on time. He was later advised that it could take seven years to get back to 800 because that’s how long federal law allows missed payments to remain on your record.
Our son has had no problem in obtaining auto and mortgage loans due to his steady employment record with large companies. Our daughter is self-employed and doesn’t earn as much as our son. In the past, I co-signed an auto loan for her to help her build her credit history, and my husband co-signed a motorcycle loan for her. Based on our insistence that her credit score (and ours) needed to be diligently protected and why, she made her all of her payments on time and paid off both loans well ahead of schedule. When the time came for another auto loan, her local credit union pre-approved her for 150% of what she actually needed at the best rate it offered, and without the necessity of a co-signer. I do wish that parents and academic institutions did a better job of educating young people about credit – building it and using it appropriately. I think that many people (of all ages) don’t realize how quickly a credit score that took years to build can be destroyed and how many years it can take to repair it once that has happened.
Thanks for sharing Mary. I’ll go a step further and say I kind of agree with some of the dissenters to this post and say I wish credit score didn’t matter as much as it does. But since we live in the world we do, rather than the one we wish we did, I’m 100% with you in wishing parents and academic institutions did a better job educating people on how credit scores work and their importance. To those ends that’s why I decided that this was a topic worth covering on the blog after ignoring it for too long.
Best wishes!
Chris
My credit score is pretty awesome, low 800’s. I have not had any debts for many years. I pay my credit card charges as soon as they post to the account. No mortgage for many years, etc. I could not understand why my score was not 850, until it was explained to me by a friend who is a bank loan officer.
One thing not emphasized nearly enough in this otherwise great article is that you can not get the highest scores without having and regularly paying installment loans. Credit card debt that is well managed will only get you so far, but without mortgage or car loans, or something like that, you can not get to 850. The authors do mention this, but do not specifically explain it. Well, they sort of explain it. You do not get a credit score without actually using credit, and for those of us at the upper end of the credit scores it is important to know why we are not at the very, very top. I was also told that 850 is unattainable for anyone not yet in their mid-60’s or above (I’m late 50’s).
Box of Rain,
As noted in my response to Mary above, I have mostly ignored this topic in my writing and frankly in managing my own finances. Just using credit cards regularly and paying them on time has kept my credit score in the excellent range. This has never negatively impacted me in any way, so I don’t care about having a perfect score. Is there a reason you do? Is there anything you fell like you’re missing out on? Or is this more a matter of curiosity for you as well?
Best wishes,
Chris
Oh, right, I totally agree Chris.
Difference in real life between credit score of 815 and 850 is probably no difference at all.
My point was just that once one is in the 800’s, and if one pays attention to their score at all, one might wonder why it is not 850. I certainly did wonder that. That’s all.
What I also would wonder about is how credit scores might impact people either at the point of retiring or in retirement. For example, I have seen some retired folks say it was hard for them to get a mortgage or a HELOC in retirement because of lack of wage/salary income, and others say it was no problem at all. I wonder if the credit score has any impact on that? We are soon to be retired and will want to sell our house and move after we retire. Timing it so that our house closes before the new house has to be paid for will be tough to arrange, so we are probably going to temporarily need a mortgage for the new house, so this is something we think about. Hoping our credit scores help that process.
Mine bounces between 830 and 848 on the 850 scale. There is also a FICO 900 scale. I don’t follow that one and I don’t know why it exists.