Credit Scores Aren’t Financial Report Cards
Have you ever received one of these letters from a bank?
“Congratulations on being a responsible credit user! We’d like to offer you an increase on your credit limit.
We appreciate your business and hope you enjoy this extra purchasing power!”
Now, to me that just looks like an opportunity to go further in debt disguised as a gift. It’s also empty praise considering I’ve paid thousands of dollars in interest to the banks over the years. If they actually wanted to help me out or empower me they could give me a partial refund on the interest I’ve paid or lower the interest rate on my student debt. …
I also only ever receive these notices when I’ve been rapidly decreasing my credit usage or haven’t borrowed in a while. When I paid off the last of my credit card debt and swore to never owe interest on them again? The credit limit increases and balance transfer offers practically flew into my mailbox, with lower transfer fees every time. They didn’t show up when I actually could have used a lower rate.
By ‘congratulations,’ they really mean ‘you’re excellent at paying us interest, and we’d like some more please.’ At this point in my life I’m wise to their ego-inflating marketing tactics, but this wasn’t always the case. In my first year or two of university I thought I was somehow behind when my credit score was low, despite having zero debt at the time! Those were the days.
At some point in our financial history we equated a high credit score with values like honesty, trustworthiness, and intelligence. Probably right around the time lenders started advertising credit as a sign of honesty, trustworthiness, and intelligence.
The Benefits of a High Credit Score
I’ll be the first to admit that a high credit score does have some utility.
Your credit score is often used to determine your eligibility for a loan and can affect the terms you’re offered, including your interest rate. It could also impact your rates for insurance, or in some professions even your employability – particularly in the financial sector and in government.
When I applied to rent an apartment, a credit check was a standard part of the process. In a competitive rental market with vacancy rates close to zero, any advantage over other applicants is a bonus. I attended apartment viewings where slumlords hosted tours for several people at a time, while those in the next time slot lined up outside. Prospective tenants showed up to viewings with applications already completed, and landlords had their pick of the top candidates out of the pile.
That being said, a credit score isn’t everything. At one point I had six figures in student loan and credit card debt, no job, no assets, a negative net worth, and a credit rating of ‘Excellent.’ The credit bureaus were giving me an A+ when my true financial health was a D at best.
One of the frustrating things about credit scores and credit repair companies is that they focus on a symptom rather than the underlying issues. Credit score ‘hacks’ like applying to increase your credit limit can increase your score because you’ll be using less of the credit you have available. However, if your credit was maxed and you didn’t resolve the situations that led there in the first place, you’re in danger of increasing your debt and landing right back where you started.
Credit scores can also create a cycle of predatory lending. Those with high credit scores are offered their choice of credit from reputable institutions, often at lower rates. Those with low credit scores are targeted by lenders who take advantage of the fact that they might not have other options. The higher rates and fees mean that borrowers are more likely to miss payments, lowering their credit scores again and continuing the cycle. It’s a catch-22. The people who are least able to bear higher costs of borrowing are the ones who end up with them.
Other (More Important) Financial Numbers
I’m not anti-credit score and I do think you should monitor your credit, especially to catch any fraudulent activity right away, but there are much more important numbers to keep in mind.
Your net worth is simply your assets minus your liabilities.
Assets include everything that you own – cash, vehicles, home equity.
Liabilities include everything that you owe – student loans, credit cards, mortgages.
For example, with $100,000 in equity, $200,000 owed on the mortgage, and $50,000 in student loans your net worth would be -$150,000.
$100,000 – ($200,000 + $50,000) = -$150,000
An excellent credit score didn’t mean much to me when my net worth was in the negative six figures, especially when my debt was all credit cards and student loans rather than something backed with an asset like a mortgage. A credit score increasing just means that you can take on more debt. If your net worth increases, you’re actually growing your wealth.
One of the important pieces of your financial picture is whether you have any money. (I know, right?)
If your credit score is high but you have $0.99 in your chequing and savings accounts combined, any emergency would have to go onto a credit card. That would be fine if you had a steady income and could pay it off before incurring interest, but what if there’s a problem with your payroll and you don’t get paid on time? Just ask the hundreds of thousands of federal employees affected by the recent Phoenix pay system debacle, including some who faced weeks or months without pay.
The only thing a high credit score could help you do in that situation is borrow more money, potentially at lower rates. If you had a healthy emergency fund, you’d be able to tackle the unexpected without paying any interest and you’d be sleeping a little easier at night too.
A tricky feature of credit scores is that yours could be high even if you’re living paycheck to paycheck with your incoming funds barely covering the bills and minimum payments. Been there too!
Credit can distort our image of what we think we can afford. Instead of considering the long term consequences of a purchase, we think in terms of whether we can make the monthly minimum payments. Sure, we might be happier at first but paying the minimum on a credit card could mean it takes you years or even decades to clear the balance. By then you might not even own the things you bought with it!
Increasing your cash flow means making space between your income and your monthly bills and payments, usually by cancelling things you don’t need or paying off debt. When you have more flexibility with your incoming cash, you lower the risk of needing to rely on credit to float irregular expenses.
Although net worth, account balances, and cash flow give a more nuanced view of financial health, these numbers aren’t everything either.
You Can’t Math Your Way To Self Worth
Numbers can’t tell you if you’re happy or fulfilled. Your self worth is not your credit score or net worth or bank balance.
Money isn’t just about the math, and it never has been. Money is about security and freedom, and knowing that you’ll be able to tackle things that come up in your life without added stress.
Focus on improving your financial health and your mental health, and think of a credit score as it truly is – a financial tool with limited utility. It gives no indication of how wealthy you are, how smart you are with money, or how trustworthy of a person you are. It just doesn’t.