- 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 not much use after hitting 760.
- Your net worth and debt-to-income ratio are two more important factors when measuring financial health.
- Read more from Personal Finance Insider.
As a financial planner who works with young, high-income professionals, I often see an unhealthy obsession with credit scores.
Clients obsessed with getting the highest credit score possible sometimes ask me if they should get an additional credit card to improve their credit score. I will explain to them that their current score is excellent in most cases, and that just increasing their score by a few points will not help them qualify for lower loan rates or better lending 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 debt tolerance.
Credit scores are calculated based on a number of factors arising from the data in your credit report. These factors do not take into account your income, savings or investments.
For example, someone who earns $200,000 a year could have very little savings and have more than $1,000,000 in debt between a house, a car, student loans, and credit cards—but even if they spend too much and live from paycheck to paycheck, they still It is possible that he has excellent credit.
An individual’s net worth and debt-to-income ratio are better indicators of financial health.
Net worth is your total financial assets (what you own) minus your debt (what you owe). In the above example, this person’s net worth is low. They are likely unprepared to deal with unexpected expenses and may fall behind saving for retirement or other financial goals.
The 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 turn to more debt just to get by. Many lenders calculate this number in addition to reviewing your credit score to determine your ability to repay the loan.
Your credit score is only important in specific situations
Sure, having good credit is helpful – but it’s only necessary in some 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 easy to borrow money when you need it. Not only is it easier to qualify for new loans, but you may also get lower interest rates and more favorable loan terms from lenders.
Having bad credit can be considered a risk even if you are a renter. The landlord may ask you to make an additional deposit, or obtain a cosigner before agreeing to the lease. A good credit score makes the process much easier.
using service providers
Some cable, cell phone, and Internet providers use risk-based rates, as they are legally allowed to charge you extra for bad credit. Some utility companies may also use credit scores to determine if you should make a deposit before using their service.
In most states, the homeowner and
Companies can use what’s called a credit-based degree of insurance to determine your premiums. This score depends on your credit history, and a lower score can lead to 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, this includes a credit check. While employment credit checks do not show your credit score, they do show your credit history and debt repayment.
However, you still have to achieve a perfect score for the lenders to view it favorably. In most cases, a score of 760 or higher is sufficient to qualify you for the lowest rates and most favorable loan terms. Focusing so much effort on achieving a score higher than this number is just for vanity metrics.
It is important to focus on public financial health
Focusing on good financial health is far more important than achieving the highest possible credit score. To maintain good financial health, you must ensure that you live within your means, save as much as you can, and track your net worth over time.
You are better off looking for ways to increase your income, invest it, and pay off any existing debts rather than focusing so much on your credit score. Also, by managing debt responsibly, you will have an easier time maintaining a good credit score and will have access to credit when you really need it.
Don’t apply for credit cards and take on additional debt just to improve your credit score. After all, the availability of excess credit can actually motivate you to spend more.
Also, don’t be afraid to pay off large debts or close credit cards that you don’t use. Rebuilding your credit score after a small drop is much easier than holding large amounts of debt or being tempted to spend beyond your means.