Credit scores, what are they and should you repair them?
The credit score is one of the most misunderstood items in personal finance. Most people do not know what makes up a credit score, much less what purpose they serve. Credit rating systems date back to 1899, but their use has been varied from their origination. In the beginning, credit reports included information like marital troubles and political affiliations. In 1970, enough people complained about the regulation and items included in credit reporting, so the Federal Fair Credit Reporting Act was passed.
The problem was that credit reporting was then placed on a pedestal to measure whether or not a person was successfully stewarding the money they had. Placing credit reporting to this standard is incredibly damaging to the average American for many reasons. None of these reasons were remedied by the Federal Fair Credit Reporting Act.
Incentivizing the use of credit as a standard of success. The first reason this is damaging is that it implies that debt is necessary to succeed in life. As a coach, I am commonly told that people are afraid to pay off debt because of their credit score. This is the first and most potent lie that the lending industry wants you to believe. Debt is the most aggressively marketed product in the world. People are giving away their entire future to make banks wealthy because they believe there is no other way. This is wrong.
The disassociation to the actual cost of buying items. Multiple studies have shown that debt vehicles' use to acquire goods causes people to spend considerably more. One such study from Carnegie Mellon found that people do not feel the same loss when using cards versus cash. When you watch bills leave you, it elicits a response in the pain center of the brain. Contrastly, when you pay with your card, you feel no loss, and you are likely not going to remember the amount you paid five minutes later. The less friction involved in purchasing items, the easier it is to disassociate the loss you are experiencing, whether that be money and/or time. I ask people often have they ever taken the total cost? Taking the time to figure out how many working hours it would take to pay back a large purchase?
Debt is often paired with deceptive rewards. All too often, lenders have to place a spin on debt products to induce people to spend more than they usually would. Let's say that you need a new shirt and you planned on spending $20. If a store pairs a 25% off coupon if you use a store card, then that pair of pants or shoes you did not need now seem like a savvy purchase rather than going over budget. This is a small example, but once in debt, we are tempted into the Diderot Effect. This phenomenon states that one purchase leads to another. In this example, that new shirt would surely make the pants you have already seem worn. These two items will make you consider a new pair of shoes, and so on and so on. How about cashback ploys or airline miles? Indeed these are not that bad, right? Let's look at the numbers. Studies show that 40% of airline miles are never redeemed, and 31 percent of people never use credit card points. (Bankrate.com)
Now, I am sure that you are wondering that if credit scores are bad, how do you get along in a society that uses them? I will tell you that credit scores are not necessary as tools to build wealth, ever. Not sure you believe me? Let’s ask over 10,000 net worth millionaires. If you do not know what a net worth millionaire is, allow me the opportunity to explain. A net worth millionaire is one who, taking assets and subtracting debts, has over 1 million dollars in positive net worth. I argue it stands to reason that those winning with money are the ones we should ask how they got there. 3/4 of millionaires never carried any credit card debt and steered clear of debt in all forms.
If you are concerned with getting a house and there is not enough time for your credit score to fall off then a better tactic would be to reduce your debt to income ratio. If you are wondering how to do this the best approach is to create a budget. Before you get out the pitchforks and tell me how much you hate budgets, trust me I know where you are coming from. As a recovering spender, I can tell you just how much freedom a budget gives you. As a coach, I NEVER tell people what they can or can’t spend money on. I work with people to give them the tools to be able to make decisions on their own. If you think you are interested in learning more and you want to take advantage of a free session click here to learn more.