Years ago, I started flipping used goods on eBay for a profit. To maintain an enthusiastic base of customers, it was imperative that I received lots of 5-star ratings from satisfied customers. Those ratings were the best way to convince other shoppers that I was a dependable, trustworthy seller. That meant my micro-business was at the mercy of my customers. I took great care to ensure that my customers had the best buying experience possible. That made it especially painful when I would receive photos from a customer showing that their package had been beaten to a pulp by the postal delivery team. In some cases, I imagined FedEx using my box as a kickball in a tournament before finally delivering it to my customer.
Lately I’ve noticed how many consumers monitor and protect their precious credit scores with even greater care than I did my eBay seller rating. That observation led me to wonder how much all that care and attention really matters. Sure, we can all agree that there’s zero benefit to having an abysmal credit score. But just how much does your credit score matter? Moreover, might there be circumstances where it makes sense to sacrifice a few points for other financial tradeoffs? The answers to these questions may surprise you.
A Brief History of the Credit Score
Until the 1950s, credit scores didn’t really exist. Before the credit score era, securing a loan was a strange personal process where an individual banker would interview the credit applicant and disparagingly look for possible holes in their integrity as a borrower. The type of autonomy those loan officers had back then would be the source of instantaneous lawsuits in today’s world. Without repeatable and uniform processes and criteria, unethical discrimination was abundant.
In 1956, statisticians Bill Fair and Earl Isaac started the company that would eventually be referred to as FICO. Their mission was to determine the strongest correlates of creditworthiness, weight them accordingly, and apply those factors to prospective bank clients. They aimed to create algorithms that were uniform and unbiased, so banks could evaluate prospective borrowers more accurately and appropriately.
Three-digit credit scores came into play during the late 1950s but didn’t become ubiquitous until the 70s. Nowadays, US consumers are nearly as likely to know their credit score by heart as their Social Security number.
How Much are Wealth and Credit Scores Related?
Before obsessing over our credit scores, we should first ask whether or not the rating is actually a correlate of wealth building.
As it turns out, it isn’t.
In the United States, there are currently over 10 million individuals with a net worth of $1 million or more. More than half have subprime credit scores!
This may seem surprising at first, but it begins to make more sense when we look at what a credit score truly measures. Or should I say, what a credit score does not measure. Credit scores don’t account for how much money an individual has stashed away in their savings account or their liquid investments. Ironically though, some banks will consider the accumulation of cash and assets to evaluate a potential borrower’s creditworthiness even though those numbers don’t appear in their credit score.
Wouldn’t you think the amount of cash and liquid assets an individual has would be a strong indication of their creditworthiness?!
Now, let’s consider the following example that highlights the potential absurdity of credit scores:
Let’s suppose you pay cash for your household vehicles. Instead of financing those purchases, you decided you’d avoid paying interest at 4.5% APR and drop the savings into your bank account. This decision certainly won’t bolster your credit score. In fact, it might actually have an adverse effect your credit rating because your credit profile lacks diversity.
This highlights the fundamental flaw in aspiring to be “King of the Credit Score.” Person A lives below his means and wisely pays cash for depreciating assets. Person A’s credit score suffers. Person B has a variety of open credit accounts that they pay on time. Person B’s credit score is excellent and continues to rise (even though their net worth is destined to grow at a slower pace).
Who would you rather be, the person with a phenomenal credit score and debt or the person with a mediocre credit score and a growing portfolio of assets?
Can I Sacrifice a Few Points on my Credit Score?
The short answer for this question is, it depends.
It depends on how much you are sacrificing and what you stand to gain.
Let me give you an example using a personal situation. To give you a frame of reference, my credit score is well above average but not perfect. It’s like a body that works out regularly but also likes to drink beer.
I recently travelled to Europe. Before the trip, I opened a Capital One credit card and an Amex Blue Cash Everyday Card. Acquiring these accounts in close succession temporarily dropped my credit score by about 15 points. What did I gain? Neither card charged foreign transaction fees and the sign up bonuses combined for over $750 that I used to trim my travel costs.
I’ll definitely invest the savings and the hard inquiries will no longer affect my credit score 12 months from now. I’ve been taking advantage of credit card sign up bonuses 3 to 4 times a year for a while now. I’m able to meet the sign-up bonus requirements by making only legitimate routine purchases. I rack up approximately $2-3k a year in bonuses. So despite the fact that my credit score is a bit volatile, the credit card bonuses and extra savings have helped me increase my cash and assets! For me, the travel perks and cash bonuses far outweigh any negatives that come from a temporary credit score dip.
Making a Game Plan
Everyone has life circumstances and financial situations that are unique to them. That means that there are infinite factors that should be considered when making decisions that will impact your credit score. For instance, let’s say I plan to buy a house in the next six months and 75% or more of the home’s value would be covered by a loan. In that case, the travel perks and sign up bonuses might not be worth it when if a lower credit score will result in a less favorable mortgage interest rate.
On the other hand, let’s say your credit score is currently 800. And let’s suppose your net worth is 80% or more of the value of the houses you’re considering. And suppose you stand to benefit from closing several credit accounts. In that case, it may be something worth considering.
What’s important is that our focus should be on improving our entire financial picture, not just our credit score. Our credit score is just one indication of how we are as consumers, but not the only indication. And certainly not the most important!
A Few Final Thoughts
When it came to eBay, my seller rating was the end all be all. None of my buyers said, “Darian has a rough rating, but let’s cut him some slack because he goes to church every Sunday.” I was completely dependent. Although there are undeniable benefits to having a good credit score, our financial wellbeing isn’t entirely at the mercy of that three-digit number.
There are times when losing a few points can make perfect sense and we shouldn’t eat our hearts out when we see the downward red arrow on our Credit Karma app. As long as you understand how much (or how little) your credit score will affect your future, you’ll be able to make wise decisions as you move through life’s transactions.