Your Credit Score is NOT a Measure of Financial Success
In the past few weeks, I have been saying this over and over: “Your credit score is NOT a measure of financial success!” I’ve said this to my coaching clients, students in my Budgeting Basics class, investment advisors, bankers, and mortgage brokers. I think I shocked the investment advisor when I told him that I don’t know what my credit score is. I don’t plan on going into debt any time soon (or ever!) so it’s not important to me.
Americans are obsessed with their credit scores. Why? Because if you want to borrow money, your credit score is important. Financial guru, Dave Ramsey, refers to the credit score as the “I-Love-Debt-Score” for good reason. Your credit score is calculated based on how you interact with debt. You need to have some debt to even obtain a credit score. But you can’t have too much. And you have to “play nice” with the debt that you have (make payments on time) to keep your score in the acceptable range.
As you can see from the pie chart above, your credit score is based on how you interact with the debt you have. It does NOT take into account whether you are employed or not, how much money you make, or what your net worth is. Are you beginning to understand why your credit score isn’t a good measure of financial success?
Let’s look at an example. Jenny makes $45,000 per year. She has a new car with a big payment, several credit cards, and still lives with her parents at home. Jenny makes all of her payments on time. She has $1,000 in her savings account and $5,000 in her 401k. Jenny has an “excellent” credit score – 815. Carrie also makes $45,000 per year. Her father drilled it into her head that she should borrow as little money as possible, and only for things that go up in value like real estate. Carrie drives a used car that she paid for with cash, and has no credit cards. She owns a small house that she has a 15 year mortgage on, which is her only debt. Carrie has $15,000 in her savings account and $75,000 in her 401k. Carrie has a “good” credit score of 740.
Do you see the problem with using the credit score to measure financial success? Jenny’s credit score is 815, but she owns nothing and has a net worth of $6,000. Carrie’s credit score is 740, but she owns her home and car, and has a net worth of $90,000 plus her equity in the house. Your NET WORTH is the true measure of financial success, not your credit score. (Your net worth is your assets – house, car, 401k, bank accounts, cash – less your loans against those assets – car loans, mortgages, credit cards, etc.)
Now, please understand that I am NOT saying your credit score is worthless and you shouldn’t care about it at all. (Just for the record, last time my credit score was pulled to refinance the mortgage I hope to pay off soon, it was in the “Excellent” range – but I don’t recall the exact number.) Your credit report and credit score will affect your mortgage loan rate (because most people don’t have the patience to save up cash to buy a house), your car and homeowners insurance rates, and your employability in certain jobs. You should pull your credit report at least once a year and make sure there isn’t anything incorrect or fraudulent on there. But please don’t obsess about your credit score! Instead, put that energy into increasing your assets and paying off your debt. Your NET WORTH is the true measure of financial success.