Credit scores are a measure of one’s ability to manage debt. The dominant credit scoring system which is used by most lenders was created by Fair Isaac. This system provides a measure of an individual’s credit worthiness and is commonly known as a FICO Score.
A credit score impacts many things. It determines whether or not you can obtain a loan. If you qualify for a loan, the credit score dictates the interest rate charged.
Credit scores also impact insurability. When you obtain auto, renters or homeowners insurance, the credit score directly impacts the insurance cost. The lower your credit score, the higher the insurance premium will cost. I have seen insurance premiums doubled because of poor credit.
Credit scores also impact the ability to obtain a cell phone contract or an apartment lease. It can affect utility connections. Utility providers usually require much larger deposits from people who have low credit scores. If you have an excellent credit score, a deposit might be waived entirely. Credit scores can even impact your ability to obtain a job. Your credit score will have an impact on your life.
Many people know their exact credit score. If it is great, they wear it as a badge of honor of their financial prowess. “My credit score is 814,” they will say quite proudly.
Others who have a more colorful experience with credit, will wear it as a badge of dishonor. “My credit score is in the toilet,” they say with a glum look.
The fact is that credit scores are only a measure of how well a person can manage debt and contractual financial agreements.
Credit scores are calculated using these data points:
- Type of credit issued [Revolving debt (credit card) or Installment debt (anything with payments and a pay-off – car loan, boat loan, student loan, etc.]
- Age of the credit relationship
- Amount of credit one can obtain (total of all credit limits)
- Amount of credit one has consumed (percentage of total credit limit)
- Payment timeliness
- Requests for credit (“hard pulls” of credit)
- Outstanding judgments
Look at the list again. Does it include any relationship to how much money one might have in a savings account? Or any connection to a person’s net worth?
Here’s the fact: You could be a millionaire and have a terrible credit score.
How? By having zero credit relationships.
While a great credit score is more desirable than a terrible credit score, it is not the best indicator of financial success. Choose instead to make financial decisions about what best increases financial margin and net worth!
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