Money

Don’t Ignore Your Credit Score

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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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