The Myth of Credit Scores

I had an epiphany in the car this morning courtesy of Dave Ramsey. On my daily commute, I listen to various podcasts. Some days it’s “Stuff You Missed in History Class” or “This American Life”, but today, I chose “The Dave Ramsey Show”.

See, I’ve been focusing on cleaning up my finances recently and I had heard many great things about Dave Ramsey. Everyone could use more financial help/direction and while I wouldn’t consider myself by any stretch of the imagination to be “struggling”, I can always learn more. I can always do better.

So, I set off on my drive and hit play on Episode #7998: “Brooke’s Parents Are in Financial Trouble.” (Notice: episode 7998… that’s insane.) After Dave coached Brooke through her situation and another caller through theirs, he came to a gentleman who was asking about paying off his car loan. During the call, he made a statement I’ve heard a lot and have even said myself.

Paying my car loan was good for my credit score.

This launched Dave Ramsey into a tizzy and I’ll explain to you why.

If you’re on a healthy financial path, your ultimate goals are to be debt free and build wealth. The core to Dave Ramsey’s plan is that you pay off your debts (credit cards, student loans, car loans, etc) and don’t take on any new debts. BUT to build your credit score, you have to have some form of debt. Aren’t these contradictory?

Absolutely. And with good reason. As Mr. Ramsey puts it:

Like it or not, your credit score is not an indicator of winning financially. All it tells you is whether you are good at borrowing money and paying it back. That’s it.

Your credit score doesn’t take into account your debt-to-income ratio or how much money you have in your savings. If you’ve ever tried to buy a house or a new car, you’re very aware of this fact.

Looking down the line, I’m thinking, “Well one day, I would like to buy a house. I will need to take out a mortgage and I can’t get a mortgage loan without a good credit score.” Eh, mostly true. Mr. Ramsey has an answer for that too.

So, I took a look at my finances again. I hate having credit cards for the sole reason that they encourage poor financial behavior. It’s so easy for me to just charge to the card and leave the worrying for later – especially if I’m getting airline miles for it. In reality, I’m just creating a debt that is increasingly difficult to pay off.

Here’s the myth:

Having a good credit score is the key to financial health.

Which is somewhat true (aka, if you’re looking to secure a mortgage). I’ve opened credit cards, prided myself on getting a large credit limit, and kept these accounts open (even if relatively unused) because length of available credit is as important as volume. I’ve been giving myself a pat on the back for the past 10 years for being viewed as low-risk investment by lenders when in reality all my good credit score really says is I’m good at keeping myself in debt to serve a number I’ve been told is important.

You know what number is more important – the number in my savings account.

(And 401(k), IRA, and other various investments.)

My credit score is healthy. I mean, I’ve been really good at keeping myself in debt and paying my bills. However, I don’t plan to buy a house for a while and when I do, I’d like to pay as much cash as possible. What else would I need my credit score for? Not much. So that being said, I closed two credit cards that had a zero balance today. I don’t need them and I don’t need the temptation.

However, there are a few places Mr. Ramsey and I disagree. One being… I will keep one of my credit cards for work expenses and emergencies (that require a credit card). Not for the sake of my credit score but because sometimes you really do need it. Some will argue that there are no situations that your emergency fund can’t handle and a credit card is required, and I will point out that they’ve clearly  never tried to pay for parking in downtown San Diego with a debit card.

Moral of the Story: Don’t be a slave to your credit score. Be a slave to your net worth.

Disclaimer: Use caution when taking financial advice from any source, including me. Not all programs work for everyone. When really in trouble, consult a financial advisor.

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