Why is credit score important? We tell you what a credit score is, how it is calculated and learning why credit score is important in this post.
As a guest blog post, I was a bit torn on what to write about. Several topics crossed my mind from mastering the gig economy to investing to power saving. What makes maximum impact? Certainly living beneath one's means has to be near the top yet there are ample articles on the power of that concept. I finally settled upon credit score and credit history as my topic and heck, what could be more basic and more boring than credit score? Perhaps yes, but it's so vital that it warrants a strong reminder.
Your credit history determines what loans you will qualify for and the interest rate you will pay. Lenders get your credit history by obtaining your credit score.
You’ll most likely need to borrow funds from a lender. This is why credit is such an important component of the mortgage process.
What is a credit score?
A credit score provides an easy way for lenders to numerically judge your credit at a point in time. It gauges how likely you are to repay your loan in a timely manner. The better your history appears, the more attractive you become as a loan customer.
Why is my credit score important?
Most people know that a good credit score is important but most people don't realize HOW important. Why is a good credit score important?
If you're striving to be financially independent I'd say that having a high credit score is essential. Because having a high credit score impacts nearly everything that's important in the quest for FIRE.
“But what if I am debt free and don't need credit?” someone might say.
Let's take a look at 5 reasons.
1. Car Insurance
Did you know that Wallethub did a study and found that ….”people with no credit pay an average of 53% more for car insurance than people with excellent credit, with some states seeing fluctuations as high as 122%.”
My credit score affects what I pay for car insurance and other types of insurance like home insurance?
Unless you live in California, Massachusetts, or Hawaii it can. I might add that the savings can be quite substantial over time.
But wait, there's more.
Many employers will want to view your credit history (not to be confused with credit score) as part of their hiring process. This is especially true of financial firms hiring people to fill sensitive positions with high temptations of thievery and fraud. It is worth noting that companies won't have access to your credit score perse but they will see whether you've paid your bills on time and the source and type of credit you've used.
Why should a company (or anybody else) take a big risk on a person and entrust them with all sorts of responsibilities if that person can't even manage their own finances? If your goal is FIRE then it helps to have a great job that pays you a lot of money and the higher the pay the more likely employers will be to dig through your background. Just another reason to get it squared away.
It turns out that your credit score and to a lesser extent credit history says more about you than any other metric allowed by law. Why is that? Because at its core, your credit score is a direct indicator of your level of conscientiousness. In its synonym discussion on the meaning of conscientiousness Merriam Webster had this to say:
“upright, honest, just, conscientious, scrupulous, honorable mean having or showing a strict regard for what is morally right. upright implies a strict adherence to moral principles. Honest stresses adherence to such virtues as truthfulness, candor, or fairness. Just stresses conscious choice and regular practice of what is right or equitable. Conscientious and scrupulous imply an active moral sense governing all one's actions and painstaking efforts to follow one's conscience. Honorable suggests a firm holding to codes of right behavior and the guidance of a high sense of honor and duty.”
Upon further thought, conscientiousness is a measure of what you do when nobody is looking and a measure of how you treat others with whom you deal with. It's no surprise then that many corporations view conscientiousness as the best measure of success.
4. Future Success
We're all aware of the fact that leading corporations gauge personalities and personal attributes in terms of which traits most indicate success. A project by Philip Walmsley and Paul Sacket published in ‘Perspectives on Psychological Science' used what's called the Five Factor Model or FFM which uses neuroticism, extraversion, openness, agreeableness, and conscientiousness to see which of those traits companies value the most when bringing on new employees and whether those traits ultimately correspond to the future success of those employees.
Their findings show that conscientiousness ranks first both in what companies value in hiring and as an indicator of future success. See here.
5. Beyond Your Credit Score
Beyond your attractiveness, as an employee, your credit score can also tell how likely it is that you'll be in an accident and how likely you are to break the law. It even tells people how likely you are to get married and stay married.
That's right. If you want to find a faithful life-partner don't mess around with love books or your gut hunch – ask for their credit score instead. How can it be any other way? Why would an unconscientious person act any differently in love than they do in their finances? Yes, there are exceptions of course and there are many outliers that are highly conscientious people who may have a low credit score due to factors beyond their control. That said, finding the legitimate exception is a subjective, often difficult task.
How does credit impact you?
We've seen above how your credit score may be used in all sorts of non-financially related things but the mother lode will be in finances and the impact may be in some things not normally associated with credit score. Your credit score may impact an apartment rental application, a mortgage application, car financing, student loan applications, and as I recently discovered it can also impact financing an HVAC replacement (not that I'd recommend doing so).
Financing anything usually doesn't make sense and is to be avoided but that's not always the case. If the day comes when you have to finance something you want it to be on the best terms possible and the lowest interest rate you can find. The higher your credit score the lower your interest rate – period, end of story. Thinking about applying for a killer travel perks credit card like the Chase Sapphire Reserve? You'd better come armed with a good credit score.
I'd go so far as to say that it's very high credit scores which best define the real global elite. A high score gives one access to many of the best deals, the lowest interest rates, the best perks, and the lowest costs. The higher the score, the cheaper it is to live – just a fact. If you need to finance something it gives you access to cheap lines of credit which of course means that it's easier to pay off the debt.
When it comes to FIRE a high credit score is perhaps your best tool for saving money to achieve FIRE and living well in early retirement once you get there. I've seen way too many people ignore their credit score and significantly harm their quality of life – sometimes for decades.
With a bad score life is a lot more expensive and yes it's pointless to whine about how unfair it is. Just do whatever it takes to increase your score and your ultimate goal should be a score above 800 on Experion's scoring system. Now for the crucial question: How does one increase your credit score?
How to improve credit score
Here are 7 things you can do to improve your credit score
1. Pay your bills on time. All of them. Don't miss a single payment – ever. If you have to eat macaroni and cheese for a month in order to pay a bill then do it. If you have already missed payments in your past life then never do it again. Never be a serial offender.
2. Choose credit cards wisely and apply only for cards which have perks and benefits you'll use for years. Why? Because the longer you have a card the higher it bumps your score. Credit bureaus compute the average length of time you've owned all of your cards – the longer the better. It goes without saying that opening and closing accounts harm your score so choose cards for long-term ownership.
3. Pay off your credit card bills each and every month. A high revolving balance or balance shifting from one card to the next will likely hit your score.
4. Rating companies compute the percentage of debt to credit you're using. You want the credit line to be very high and the ratio of debt to that credit to be very low. If you are authorized to take out $10,000 and you have a balance of $5000 that's a high 50% debt ratio and it will negatively impact your score. If, on the other hand, you're authorized to take out $50,000 and you have a balance of $5000 that's a low 10% debt to credit ratio and your score will improve significantly. The most important threshold is 30% debt to credit ratio with anything above that impacting your score. It's important to know that you can be penalized even if you pay your balance in full every month if you bust the 30% threshold as card companies may report balances at different times of the month. Call your card company and ask them if they can increase your credit limit. It's worth a try. The best situation, of course, is to have zero debt with a very high debt limit which shows the rating firms that you have discipline and can manage your finances responsibly.
5. Pay off revolving credit such as credit cards first.
6. Have credit cards. Yes, that's right. It's better to have credit cards and to manage them responsibly than to have no cards at all and not establishing credit.
7. Do not open accounts in rapid fashion – especially when young and trying to establish credit.
Your credit score is important
Even if the credit scoring system doesn't seem fair to you, rebelling against the system by not monitoring your credit health isn't going to change the process. If anything, it may hurt you. A good starting point should be finding out your credit score, you can monitor your credit score on Credit Sesame for free. So you'll know as soon as anything changes.
There you have it. Do whatever it takes to improve your score. Not only will life become a lot more affordable but a high score may help in ways that you don't even see. Good luck!