A high credit score is not the best indicator of financial health
- As a financial planner, I find that many of my clients are obsessed with having a high credit score.
- A high score is important for borrowing money, but there isn’t much benefit after you hit 760.
- Your net worth and your debt ratio are more important factors in measuring financial health.
- Learn more about Personal Finance Insider.
As a financial planner who works with young, high-income professionals, I often see an unhealthy obsession with credit scores.
Customers who are obsessed with having the highest possible credit score will sometimes ask me if they should take out an additional credit card to improve their credit score. I will explain to them that their current score is considered excellent in most cases, and that increasing their score by a few points will not help them qualify for lower loan rates or better loan terms.
Credit scores are not a measure of your financial health
Contrary to popular belief, a high credit score is not a measure of financial health, it is a measure of your ability to take on debt.
Credit scores are calculated based on a number of factors derived from the data on your credit report. These factors do not take into account your income, savings or investments.
For example, someone earning $ 200,000 a year might have very little savings and have over $ 1,000,000 in debt between a house, car, student loans, and credit cards – but even if they are spending too much and lives paycheck to paycheck, she might still have excellent credit.
Net worth and the debt-to-income ratio are better indicators of financial health.
Equity is your total financial assets (what you own) minus your debt (what you owe). In the example above, this person’s net worth is low. They are probably not prepared for an unexpected expense and are likely behind on saving for retirement or other financial goals.
Your debt-to-income ratio is the total amount you owe on debt each month divided by your monthly income. The more debt you have, the higher your fixed expenses.
A high debt-to-income ratio can lead to more stress and you may have to take on even more debt to get by. Many lenders calculate this number in addition to examining your credit score to determine your ability to repay a loan.
Your credit score only matters in specific situations
Having good credit is certainly beneficial, but it is only essential in certain cases. Here are some examples of when your credit score matters:
Take out a loan or get a new credit card
Whether it’s a mortgage, car loan, or credit card, a higher credit score makes it easier to borrow money when you need it. Not only is it easier to qualify for new loans, but you can also benefit from lower interest rates and better loan terms from lenders.
Rent an apartment
Having bad credit can be considered a risk even if you are a tenant. The landlord may ask you to make an additional deposit or have a co-signer before approving you for a lease. A good credit score makes the process much easier.
Use service providers
Some cable, mobile, and internet providers use risk-based pricing, where they are legally allowed to charge you more for having bad credit. Some utility companies may also use credit scores to determine whether you need to make a deposit before using their service.
In most states, the owner and
companies can use what is called a credit-based insurance score to determine your premiums. This score is based on your credit history, and a low score can result in higher premiums.
Some employers do credit checks (but they won’t see your score)
Depending on your industry, some companies require a background check as a condition of employment. Sometimes that includes a credit check. While job credit checks don’t show your credit score, they do show your credit and debt repayment history.
That said, you still don’t need to achieve a perfect score to be viewed favorably by lenders. In most cases, a score of 760 or higher is sufficient to qualify you for the lowest rates and the most favorable loan terms. Concentrating too much effort on getting a score above this number is purely for vanity.
It is more important to focus on overall financial health
Focusing on being financially healthy is far more important than getting the highest possible credit score. To maintain good financial health, you need to make sure you’re living within your means, saving as much as you can, and tracking your net worth over time.
You are much better off looking for ways to increase your income, invest, and pay off existing debt than focusing too much on your credit score. Plus, managing debt responsibly will make it easier to maintain a good credit rating and access credit when you really need it.
Don’t apply for a credit card and take on extra debt just to improve your credit score. After all, the availability of excess credit may actually cause you to spend more.
Plus, don’t be afraid to pay off large debts or close credit cards you don’t use. Rebuilding your credit score after a small dip is much easier than carrying on big debt or being tempted to spend beyond your means.