Why Your Credit Score Matters (Even When You’re In Debt)

Smart Money Debate - Why You Need to Worry About Your Credit Score

Welcome to the 4th Smart Money Debate at ReadyForZero! To see the other side of this debate, read Brad’s post: Why I REFUSE to Play the Credit Score Game. And then let us know which argument was more convincing!

David Weliver is the founding editor of Money Under 30, a blog providing simple, honest financial advice for starting out. He says he stupidly amassed (and then completely paid off) $80,000 of consumer debt – all before his thirtieth birthday. He lives with his family in Portland, Maine.

Why Your Credit Score MattersImagine you’re a gunsmith living in the year 1875. You’ve heard stories of amazing opportunities to supply cowboys with weaponry to defend their families against bandits, so you pack your bags, ride the Pacific Railroad and set up shop in a booming Colorado mining town.

Business is good, and soon you discover that you can’t afford to buy enough metal to keep up with customer demands. So what do you do? You go to a bank and ask for a small loan.

But there’s a problem. You’re new in town, and the banker doesn’t know you. In fact, he can’t find anyone in town who does know you. So he refuses to lend you money, until you can find somebody the banker does trust to vouch for you.

Back in the day, that was credit. If somebody could say “Yeah I know Dave, and he pays his debts”, then you could borrow money. If not, or if you had a reputation for defaulting on loans, banks wouldn’t do business with you.

Fast forward 137 years. The world is bigger, faster, and a lot more sophisticated. In the modern U.S., we have a new way of determining how trustworthy somebody is (with money, or as I will point out, in other areas, too): it’s called a credit score.

This seemingly simple three digit number is based upon millions of data points about how people borrow and repay money. Through all that number crunching, a credit score tells somebody — in a matter of seconds – how likely you are to make good on a future obligation. And in those few seconds, people will decide whether to loan you money, what interest rate to offer, how much to charge you for insurance, whether to rent you an apartment and – sometimes – whether to offer you a job.

Are credit scores fair?

Well, if your score is above 800 (which is excellent by most accounts), you probably think so. But if your credit score is not-so-great because you got sick without insurance and couldn’t pay a bunch of medical bills, you probably disagree. And it’s true: a credit score can’t tell the difference between a good person who got slammed with medical bills and a bad person who routinely wracks up credit cards and never pays the bill.

For the bad guy, the bad credit score will make sure he doesn’t get another loan or become the bookkeeper at your local church. Unfortunately, however, the good person with bad credit will face the same scrutiny.

It’s not okay to ignore your credit

Brad, my opponent in this debate, is a friend of mine. We’ve been blogging alongside each other for several years and have similar stories about beating debt and turning our finances around. But Brad is going to argue that you can live life without caring about your credit score, and I disagree.

When you’re in a bunch of debt and scrambling just to get out, you don’t want to take on new credit, so it’s not that important to have a good credit score. And as you go through this experience, it’s commonplace to say “Look at all this trouble borrowing money caused, I’m never going to do this again. I don’t need debt and I don’t need my credit score.”

That’s noble: I totally understand shunning credit card balances and paying cash for cars and other items. I do that myself now. But what if you want to – someday – buy a new home? Unless you live in a very affordable area, most people can’t save the cash it takes to buy a house outright; they’ll need a mortgage.

Bad credit will cost you (tens of thousands)

If you have really bad credit, you may not be able to get a mortgage at all. But even if you can get approved, the lower your credit score, the higher APR you’ll have to pay. According to financial journalist Liz Weston, somebody with a credit score of 650 who gets a 30-year, $400,000 could pay over $70,000 more in interest that somebody with a 750 credit score. Over a lifetime of borrowing, she estimates the 100-point gap in scores could cost $201,712 in extra interest payments!

Your credit score is used for more than just lending

“But I already own my home,” you say. Or: “I’m going to rent for life!”

Fair enough. You’ll still want good credit.

That’s because – like it or not – the world uses credit scores to make decisions about more than just lending money. For example, the insurance industry uses credit scores to determine how much to charge you for auto insurance.

It’s also common for landlords to run credit checks on prospective tenants (even though rent payments aren’t usually included in credit scoring models).

Perhaps most alarmingly, it’s often legal for employers to check the credit of prospective employees, especially if your job will deal with sensitive information or give you access to company accounts. In fact, 60 percent of employers admit to checking the credit history of some job candidates, according to a study by the Society for Human Resources Management. So if you want to avoid an uncomfortable conversation with a prospective employer or a lost opportunity, it will pay to stay on top of your credit score.

You can ruin your credit in a few months, but it takes years to build good credit 

If you’re digging out of debt and don’t plan on using credit for a long, long time, there’s no need to obsess over trying to improve your credit score. Instead, you should aim to keep it healthy by avoiding anything that will hurt your credit.

This is why: It can take just a month or two of missed payments on a single credit card to send your credit score tumbling, and negative items like collections and charge offs can legally stay on your report (and influence your score) for up to seven years, according to the Federal Trade Commission’s Fair Credit Reporting Act. Good credit is built (or rebuilt) slowly by month after month of timely payments, and it can take years to undo damage caused by just one or two mistakes.

Usually, you can maintain good credit just by doing the right thing

Hopefully I’ve given you some good reasons to care about your credit score. But if I’ve failed to persuade you, let me say this: if you do nothing to specifically build good credit, remember that you can usually maintain good credit simply by living responsibly.

Although it’s true that you will not build credit if you never borrow money, assuming you have a mortgage or a credit card that you use and pay off monthly, you can maintain a healthy credit score by doing what’s right:

  • Paying your bills as agreed – on time, every time
  • Only using a small and prudent amount of your available credit
  • Avoiding applying for excessive credit
  • Once a year, requesting a free credit report at annualcreditreport.com and disputing errors or fraud with the three credit bureaus

Yes, it’s unfortunate that we have to play by arbitrary rules created by Big Financial in order to maintain a good credit score. And, no, credit scoring isn’t always fair. That said, I think the benefits of playing by the rules and having good credit far outweigh the costs of rebelling and saying “I don’t need ya!” to the credit system.

To see the other side of this debate, read Brad’s post: Why I REFUSE to Play the Credit Score Game.

Image by jerseygal2009

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  • I love this debate Ben. You have some great points in your article and I would like to expand on two points that should be made more clearly:

    The vast majority of employers will review your credit Report, not Score. Many Financial Services will look at a score and I would hope FICO, Experian, TransUnion, and Equifax look at it – but that is a small segment of the workforce.

    Yes, Insurance and Mortgage Lenders use FICO scores but they can, and by law they should, offer manual underwriting or consider “shoebox credit” (ECOA Reg B). Proof of credit worthiness can be done via other avenues like eCredable.com which proves that you pay your electric bill, your cell phone bill, even rent payment every month – things that will never effect your FICO score one bit unless you DON’T make the payment.

    It was great to sit next to you at FinCon12. Maybe next time we’ll actually get to talk to each other!

    • Steve, I’m glad you clarified about the difference between checking a credit report and a credit score. If your credit report is good, then in some cases your credit score (or lack of one) may not matter. I had not heard of eCredable before, but I will take a look at it – thanks for the heads up. I feel like I met you at FinCon, even though we didn’t get a chance to talk one-on-one, but next year we’ll definitely have to actually meet! Also, sorry your comment got purged by Disqus for a few days – not sure why that happened!

  • You CAN get a mortgage without a credit score through a process called manual underwriting, so getting a mortgage doesn’t absolutely depend on a good score. Neither does getting a job, renting, insurance, or anything else. You just have to be proactive in these situations and let them know up front that you are out of debt and that’s why you have a very low or no credit score.

    There is also an alternative score from a company called eCredable that can give you a score based on paying your regular utility bills on time that can serve as a measure of your responsibility with money.

    Having a FICO score means you have debt. I don’t want any more debt so I really see no circumstance where a FICO score will do me any good. I’m getting along without it just fine.

    • I obviously agree.

      All the points made in this post fail to acknowledge that there are alternatives to building and worshiping a credit score to prove financial worthiness.

      The thing is that manual underwriting isn’t new. It has been used for many many years long before the FICO scoring system was created. Now there is eCredable that gives people who choose to opt out of he debt score game a way to prove that they are financially responsible but just don’t have the credit history because they do not borrow money etc.

      If I want to rent an apartment it’s as easy as bringing a copy of my credit report and savings statement to show the landlord. I can rent a car without a problem.

      I think the problem is that not enough financial minds have stepped outside of this way of thinking to really truly realize how obsolete and dangerous a credit score really is. I think you have to truly not care to really be open minded enough to accept the truth.

      • Veronica @ Pelican on Money

        I’ve never heard of ecredable, thanks for bringing it up! I personally believe credit scores are perpetual modern day slavery mechanism that haven’t evolved into accurate methods of determining a person’s accountability.

        • Oddly enough, I had not heard of it myself until I heard Steve from MoneyPlanSOS mention it at FinCon12 for his IGNITE presentation. Modern day slavery is right and the masses are playing right into their masters hands. Not me! 😀

    • Thanks for your comment – this is a very interesting and informative discussion. I have one question about your statement that you don’t need a credit score: what if you either (A) would like to buy a house and cannot meet the requirements of the manual underwriting process, such as 20% down and 15 year mortgage, or (B) would like to rent an apartment that requires a credit check? These seem like two very common situations where having no credit score would prevent you from achieving your goals.

      • I will say this and it may chap some hides but it’s what I sincerely believe. For people that cannot afford to put 20% down I do not believe they can afford to buy a house. Bold statement I know, but if you look at the housing bubble and what went wrong after it burst it was clear that too many people had a mortgage they shouldn’t have had making the housing crisis even worse afterward. People don’t want to hear this because they feel entitled to having a piece of the American Dream. Home ownership shouldn’t be seen as an entitlement it should be seen as something you work hard to acquire with a little more effort than signing a loan document that requires little to no money down.

        No landlord in their right mind would turn someone away that could prove that they pay their bills every month, has significant savings, and no debt. In my opinion the person who fulfills those requirements is much less of a risk to the owner than someone crippled with debt but “at the time” has a good handle on all of it. What if 3 months after someone who has passed a credit check has a serious medical emergency. Guess what they are gonna do? They are going to run up more debt because their lines of credit have given them no reason to save for a rainy day. More debt and bigger minimums equates to someone who is going to have a much harder time paying their bills.

        Do you agree that someone with no debt, significant savings, and pays their bills on time is more likely to pay their rent each month? With the proper documentation, I think a smart landlord will come to the same conclusion, don’t you?

        • I agree with you, Brad, except for one point: “No landlord in their right mind would turn someone away that could prove that they pay their bills every month, has significant savings, and no debt.” Unfortunately, there are many landlords, especially corporate property management companies, who would either prove this statement wrong or who perhaps fall into the “not in their right mind” category. Either way, I’ve rented some apartments I likely would not have been able to get without a credit score (although to be fair, I didn’t actually try). 🙂

          • I almost wish that I wanted to live in a corporate apartment complex just to see, but even if you’re right there are still other options for people who choose to live without a credit score. There are plenty of non-corporate apartments and especially homes available.

            And I have an update that I think is pretty interesting. What if doing everything I have done (including having zero credit history and zero debt), without a worry or concern for a credit score meant that someone could still have a “good” credit score???

            I’d say this new evidence only proves that FICO is a joke as well as that chasing your credit score is a joke. I checked my credit score and although I’ve done everything I shouldn’t have done and nothing I should have according to the experts, my score is actually above 700. All 3 of them!

            In fact, I will reveal on Wednesday just how much my score has gone up in 16 months. You might be surprised by what I reveal.

            Look for it on Enemy of Debt on Wednesday! 🙂

          • That sounds intriguing. I look forward to seeing your post on Wednesday!

      • I agree with Team EOD. If you can’t meet those requirements, then wait until you can. Those requirements are there because they make good financial sense and reduce risk for you and the mortgage lender as well.

        Meeting those requirements shows that you are a pretty responsible person financially.

  • Ben, you bring up some great perspectives. I would like to point out 2 things:

    Most landlords check credit Reports, not credit Scores. A good or great FICO score is irrelevant.

    Financial institutions might check credit scores, but the majority of people doing the hiring are looking at the credit report for any indications of a problem (bad debt or late pays).

    However, I would expect MyFICO, Experian, TransUnion, and Equifax to evaluate potential employees by their scores – kinda like Ford wanting you to be in one of their trucks when you come work for them.

    • Again, you’ve made a good point by distinguishing between credit scores and credit reports! In the past, when I’ve had my credit checked, I have assumed it was the score being checked, but perhaps in many cases it was actually the credit report.

  • Many people, especially in the economy of the past 5 years, have debt that is often a matter of life or credit.
    Struggling to keep a credit score in the face of tough financial decisions has all too often led to poor financial decisions in my experience.
    If you have a debt problem, deal with it the most rational way possible first. Kick credit score concerns to the curb. Credit recovers. Faster for some, slower for others. But it will bounce back.

    • Hey Michael, thanks for bringing this perspective to the table. I think you are absolutely right! If it comes down to a choice between protecting your financial future by eliminating debt (and taking a temporary hit to your credit score) versus jeopardizing your future by striving to protect your credit score, I’d say the former makes more sense.

  • David Weliver

    To be honest, I was not familiar with manual underwriting or services like eCredible, although I think I was careful NOT to say that you can’t get a mortgage if you don’t have credit…obviously I’m aware of options like seller-provided financing, etc.

    That said, going through traditional channels (i.e., building credit) will provide a lot more home financing options and probably make the process faster, easier, and allow more choices (which usually means paying less).

    As with jobs, insurance, and apartments, I’m sure you can find all of the above that don’t care about your credit, but there’s always the possibility that the ONE job or apartment you want will require good credit. That would suck.

    Finally, if it’s one’s prerogative to live a totally debt-free lifestyle, that’s awesome. If you never take on debt, you won’t have credit, and I get not caring about credit scores because living debt-free is more important. But I would contrast this to somebody who is going to use “I don’t care about credit scores” as an excuse to be irresponsible with debt and not pay my bills. That’s a dangerous side effect of the flip side to this argument!

    • Dude we definitely agree on the fact that people should be paying their bills. The people who do not care about their credit scores for the wrong reasons this discussion really won’t matter much either way.

      To be completely honest with you dude, I just heard about eCredable too! In fact it was Steve from MoneyPlanSOS that mentioned it in Denver that I heard about it fort he first time. I think that’s a great service to provide people who have bad luck with something like high cost medical debt etc.

      No doubt using a credit score is probably faster and a little less hassle, but I am totally happy to put up with a few hiccups here and there in order to live the simple debt free life I want to. 🙂

      Great debate my friend! I really enjoyed this and I hope Ben throws some more things like this together in the future. 🙂

      • We’re definitely planning on it! If you all have any ideas for future debates, just let me know!

  • realsmart987

    I have a question.

    I’ve had my first and only credit card for about 10 months now (with Capital One) and I spent $7,200, over the life of the card without ever missing a single payment. In fact I paid off any and all debt I had as soon as I got my paycheck.

    If I stop using the credit card for anything and pretend it doesn’t exist or it’s closed WITHOUT actually closing the account will my credit score be useful for getting a house 10-20 years from now? This is the only line of credit I ever had or will have.

    I’ll still check the account a few times a month for any surprise $0.50 “interest fees” that appear for no reason (that’s happened a few times already) to dispute it. On a tangent, they always give me a free $10 to my credit account whenever I bring up this mystery fee in the phone call because I pay on time.