Credit Scores: Playing the game

If you’ve been following my posts, you probably realize I’m not very excited about debt.  Like most things I’ve ever wanted in life, a great credit score is something that I wanted for years and today don’t care to use very often.  I used to be all about getting the best interest rates, but today it’s about saving as much as I can to build wealth and realize my next big dream of owning a house I designed, on a good sized lot, away from people.  Well, far enough away that my Great Danes barking near the house won’t both my neighbors. 

Image from wsj.com

I learned a long time ago, building credit is a like a game.  It’s you against your creditors.  If you minimize your balances and carry almost no credit card debt, don’t open new accounts often and always pay on time, you will build a great score after several years with minimal interest paid, and you win.  If you’re impatient, run up your cards near or over their limits, and pay late, you’ll suffer financially and you lose on interest and fees and your score is lower. My advice is to never open a card account if you don’t have self-control.  I do admit having self-control with credit and the self-control to stick to a budget is pretty much the same thing. 

Throughout the years, I have found it much easier to spend on credit.  Every automobile I have purchased was on credit, although through each car acquisition, I had more down and a priority to pay off the load as fast as possible.  Now that I have enough saved to go out and buy a car with cash, I wouldn’t dream of parting with my hard-earned cash.  I’ll continue to enjoy my paid-for truck for years to come. 

What makes up your credit score?

Generally, there are five attributes that are counted in your credit score (listed in order of importance):

  • Payment history:  Do you pay on time? (35%)
  • Amounts owed:  How much of your credit lines are utilized? (30%)
  • Length of credit history:  How old is your oldest account and the average age accounts? (15%)
  • New credit:  How many new accounts do you have and can you manage them? Inquires? (10%)
  • Types of credit used:  What is the mix of cards, installment loans, and mortgages? (10%)

For more detail on what makes up the average credit score, check out this old CNBC post as it is still relevant today!

Each attribute is weighted more than the other because paying on time is more important than your credit mix, but it all adds up.  This is why you can build a decent score in as little as two years, but it will take seven or more, and take multiple loan types, to show you really know how to handle your debt load.

To have the best scores, you should rarely apply for new credit.  Once you find a great credit card, if you use one, stick with it.  Don’t try to open up new cards in search of better rewards.  Also, if you do open a new credit card, do not close the old one unless it has an annual fee.  Try to keep the card active by charging something every few months and paying it off before interest accrues.  I have a lot of good card accounts that I have obtained over the last 20 years, and keep open just because of age and the high limits help me ensure that even if I have a balance of $5,000 or so one month, my utilization is only around 2-3% of my total credit lines.  Always keep your purchases well below your limits.  If you keep getting close to the limit but pay it off before interest is due, apply for a credit line increase to help keep your score high.  Remember the credit is like having money.  The more you have, the less you need, and the more attractive you are as a borrower (until you borrow too much!).

As far as credit mix, having auto loans, student loans, and mortgages will all help your score.  Mortgages are considered “good debt”, which is debt that shows you are really responsible and making sound financial choices.  Also, it usually means you have equity and assets, which means if you don’t pay your creditors, they can try and put a claim towards your assets and gives them a little more assurance you will pay them back.  Most people who own homes are responsible and want to keep their home, therefore why credit card companies love homeowners.  If you have not assets, besides retirement assets, you are judgment proof and if you default, creditors will have no asset to try and claim, so all they get to do is put a bad mark on your credit and make it impossible for you to borrow until you clean up the mess or it ages off your report in a decade.

Earlier, I mentioned that I don’t strive to have the best credit cards or brag about my credit score.  As I’ve learned through the years, showing how much you can borrow through flaunting lavish houses and flashy cars is not the best use of credit.  Instead, build credit to get the best mortgage rate and know that insurance companies look at credit scores when setting auto premiums.  When you do borrow, do it strategically.  For instance, I really am tempted to pay down my mortgage, but my interest rate is so low, that I feel good having a beefy emergency fund and plunking a large amount of my paycheck into retirement.  Based on historical, long-term returns, I will come out ahead having my cash compounding at 8-12%, rather than at 3%, which is what I get while I pay off my mortgage. 

I do agree with Dave Ramsey that you can pay your house off quickly and then shove boat loads of cash into investments afterward, and probably come out about the same, and there is more risk involved with holding a mortgage, but I do insure against potential chaos with a large emergency fund. If I had kids depending on me, I might change my strategy, but being single, I feel pretty good about my risk levels. 

How do you feel about the use of credit scores in consumer lending?  Is it a fair practice?  Do you think that creditors should look at other factors besides a score? Leave me a comment! I’d love to hear from you.

What chould you be doing with your money in these unprecedented times?

As I write, our economy is coming to a screeching halt.  Life is going from freedom to confinement at home.  It almost feels like you are taking your life in your hands to leave to go to the grocery store, where controls have been set up to stop overcrowding and hoarding of commodities.  Large, multi-national companies such as GUESS, Bath & Body Works, and The Cheesecake Factory are either closing their doors for at least ten days or highly modifying operations to combat the spread of COVID-19 (Coronavirus). 

Hopefully you aren’t on the receiving end of any financial impacts from these closures through layoffs or furloughs.  If you are, I send my best hopes that you have a plan in place and an emergency fund.  Our leaders in Washington are trying to minimize the impact of this outbreak on our economy.  Today there is talk of potential cash stimulus being sent out in the form of $1,000 or more checks to individuals.  Such drastic measures seem to be gaining bi-partisan support and if leaders really do act swiftly, we could see money in the next two weeks.  So, what should you do if you get some extra money from the government?

First, remember why this money is being sent out:  to help people cope with unexpected expenses or loss of income due to COVID-19 impacts.  Perhaps you end up getting laid off from your restaurant or retail job, without pay?  You need to save this money or keep the lights and food going in your home.  If you do lose your job, try applying for unemployment insurance through your state.  Don’t be too proud.  It is meant for us in times of need! Even if you are currently secure, the most prudent thing to do would be to add this to your savings for now.  Perhaps in a few months this will all be over and will be remembered like an apocalyptic movie.  If that scenario pans out, then go spend your windfall this summer.  The worst-case scenario would be you losing your job due to a continued downturn in the economy.  In this case, you again need that extra money.

Image credit: https://tenor.com/view/trump-stock-market-explosion-down-gif-16459871

For those of you with investments that are tanking due to the markets almost literally going off a cliff the last two weeks, just hang tight.  Hopefully you weren’t planning on retiring in the next week or two since you hadn’t reallocated your funds, so you’re in it for the long run.  Just keep working as long as you are gainfully employed and contribute like you have been.  If you can, it is a good time to ratchet up your contributions because stocks are on sale and your contributions to retirement plans buy more shares! 

If you have cash well beyond your emergency fund of three to six months, it may be a good time to buy up some cheap stocks now, or in the near term, of companies that have been dragged down but have great long-term prospects.  I can’t believe how discounted UPS and FedEx shares are since people are now stranded at home in many areas with only e-commerce to scratch that retail therapy itch.  Also, some strong retailers such a GUESS and American Eagle Outfitters have seen their stock dump by as much as 75% since last month.  Although they will be closed for ten days, it is highly unlikely solid companies will go under and within a year, it is likely share prices will return to where they have been in the past year.  If stock picking isn’t your game, then buy an index fund that follows the DOW or S&P 500.  If you have cash to invest now, it is likely you will see the biggest rewards for buying when everyone else is running for the exits.

These are just a few suggestions on how to manage your money in these uncertain, yet opportunistic times.  I would love to hear how you are managing your finances today.  Are you doing the same thing as before, are you saving more, investing, or doing something completely different?  Leave a quick comment below!

It’s also a great time to give money or time to those in need!  If you can spare it, see if you can support those in need in your local community.