When the Credit Score Mania Goes Too Far

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in Credit

credit cards score healthAn article on a well known website (not another blog) caught my attention the other day. I’m not going to disclose the name of the site or provide a link to the article since it is, more than anything else, representative of a mindset in the financial world that I mostly disagree with.

The post gives tips on financial moves that will hurt your credit scores; we never want to do that if we can possibly avoid it. So far so good. The problem I have however is that the moves they recommend are mostly the type that fail to improve your cash flow situation, which for my thinking should be the basic purpose of most any financial strategy.

No, the article claims, make these moves and your credit scores will suffer. As if the primary objective of managing our finances is to maintain a golden credit score. Forget about paying off debts or lowering monthly payments, the purpose of credit it to maximize your credit scores—presumably—so you can get more credit.

Pardon me for daring to suggest it, but isn’t a major component of personal finance an effort to reduce our dependence on credit and, ultimately, to become debt free?

These may help your credit scores, but they’ll definitely hurt your finances

Here are some of the suggestions made in the article that will help to keep your credit scores at their high altitude best. They represent the typical suggestions made by credit score advocates everywhere. Don’t get hung up on them right away; we’ll go into more detail on each in a little bit, including why they’re bad for your finances.

Here’s what they recommend that you NOT do:

  1. Settling past-due debts with a creditor to pay less than you owe
  2. Transferring balances from a high-interest account to a low-interest account
  3. Closing old credit cards
  4. Paying off a car or a mortgage
  5. Avoiding debt completely

Even if each or any of these will improve your credit score, notice that doing the opposite of what’s suggested will also provide tangible improvements to your overall financial situation.

Settling past-due debts with a creditor to pay less than you owe

It is true that settling your debts for less than face value will hurt your credit scores. But most people who face this choice have bigger issues than keeping a happy credit score. If debt is a problem, and you have a chance to eliminate some of it by settling out, then take advantage of it. Only when some of the debt is gone will you be in a position to move forward.

What credit score mavens neglect to mention is that all credit contributing to your scores is temporary. As time passes, derogatory information will matter less and less until it goes away completely. If you’re struggling with debt, you already have problems that need to be addressed. Take care of getting rid of as much debt as you can, then worry about your credit scores later when you’re in a better position to do so.

Transferring balances from a high-interest account to a low-interest account

This was the one on the list that I have at least some sympathy for but I’m less concerned with the affect of the transfers on credit scores than on where this usually leads.

In most instances, good intentions notwithstanding, moving balances to lower interest/lower payment credit lines is just a means of coping with debt—or put another way—of finding a way to live with it long term. If you are going to make a move like this, do so only if you’re serious about paying the loan off—serious as in you have a workable plan in place to make it happen.

If you do, don’t worry about how it will affect your credit scores and focus instead on how you can use it to clear your path to get out of debt.

Closing old credit cards

This one hits at credit score junkies’ favorite preserve: credit utilization. (Doesn’t the sound of that just convey some sense of credibility???) Simply put, credit utilization is the amount of debt you owe compared to the total amount of credit (think of the unused portion of credit card lines and home equity lines of credit you have) expressed as a percentage.

For example, let’s say that you owe $10,000 in credit cards, but the total of your open lines is $25,000; this translates to a 40% credit utilization rate. The lower the rate, the better it is for your credit score.

In keeping with this, credit score fans advise us to keep open as many cards with the biggest lines possible, even if we don’t use them or necessarily need them. That strategy will boost our scores.
While this is true, there are risks to doing so. The more credit lines you have open, the more chances there are for identity theft. More credit lines also hold open door for potential spending sprees. Some credit cards will even charge you an annual fee even if you haven’t used a credit card all year.

Paying off a car or a mortgage

Credit scores give greater weight to some debts than to others. Mortgages and car loans have a greater impact than credit cards and furniture loans. By keeping such debts open and paying them faithfully, the positive impact on your credit scores continues uninterrupted.

Let’s say for a moment, that by paying off my car or my house, I’ll totally demolish my credit scores; you know what? If I’m in a position to pay them off, that’s exactly what I’d do!

No credit score, no not even the highest one attainable, can replace the feeling of owning a major asset free and clear. Less money to the banks each month means more money in my pocket and more money in my savings account. Is this not the ultimate goal of money management? Would I trade that for a better credit score? Not a chance!

Avoiding debt completely

The theory here is that if you have no debt you eventually fall off the credit repositories radar screens and your credit scores then head into oblivion. That has not been my experience. The people who uniformly have the highest credit scores are typically senior citizens who long ago paid off their debts and continue to maintain debt free positions.

It seems to me that avoiding debt stands head and shoulders above just about any other single piece of financial advice as the very best thing you can do. Avoiding debt is financial pay dirt; forget about what it will do to your credit scores, and go ahead and avoid all the debt you can.

My concluding thought? The heck with credit score juicing schemes; do what you have to do to get out of debt and stay out. The less debt you have, the better. If you don’t have credit, you don’t need it. Focus on paying down and paying off your debts and let your credit scores fall where they will. Better a debt free position and a mediocre credit score, than a sterling credit rating and a mountain of debt.

Oh and one more thing…like the senior citizens discussed above, pay off your debts, stay out of debt and your credit scores and you might get an uexpected bonus: your credit scores just might improve.

Do you ever find yourself getting caught up in credit score juicing schemes? Do you manage and juggle your credit to get better scores? Do you track your scores regularly? Do you feel as sense of accomplishment when they rise and fret when they fall?

(photo credit: Shutterstock)

Kevin At Out of Your RutThis post is from FiscalGeek staff writer: Kevin Mercadante. I’m very excited to have him contributing to the site. You can find out more about him at his own blog OutOfYourRut.com.

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{ 5 comments… read them below or add one }

twentysomethingmoney 2010/12/27 at 4:52 pm

The most interesting thing I had happen with my credit score, is that I was looking to buy new car, and shopped a few different dealership. When I test drove, each dealership ran my info to see what credit I could be approved for — thus, in the span of 2 weeks, I had 4 different lookups into my history. It didn’t HURT my credit score, but it could make people start to wonder and if I were planning on taking out MULTIPLE loans in a short period of time.

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Kevin 2010/12/27 at 8:04 pm

twentysomethingmoney – That IS something to worry about as well. What the car companies did in pulling your credit is to create “inquiries” on your credit report. If you have too many in a short space of time, it will negatively affect your scores for the very reason you’ve given.

My thinking is that we need to do what makes sense–keep debt to a minimum and pay them on time–and the scores will take care of themselves.

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Spedie 2010/12/29 at 10:03 am

As Dave Ramsey says, the purpose of a FICO score is to get in debt, stay in debt, make lots of debt payments and do so for your entire lives. This is how to make bankers and other credit agencies wealthy….at the expense of the consumer.

Most people never gain financial independence. They believe the stuff the experts dish out and struggle in their retirement years and die broke, or die broke and in debt.

I read a statistic once that 96% of people die broke, or die broke and in debt.

The other 4 percent do okay, with one percent of the group wealthy.

I don’t give a rats about my FICO. Since paying off my last loan other than the house, my FICO has risen about 35 points. This has taken 3 years. I now stand at a 758 according to one of the 3 bureau’s.

As for me….I plan to be in the upper 4% of the population. I don’t play the game of “let’s make bankers rich” anymore. I plan to use my money for my benefit.

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Kevin 2010/12/29 at 5:45 pm

Spedie – I’ve seen that 4% number before so there must be some legitimacy to it. Most people are in the 96% because of debt. They have to have what they want now, whether or not they can afford it and make up the difference with debt. That cycle is largely why debt consolidations, rock bottom interest rates and credit scores become so important.

For most people, adequate retirement savings won’t happen without first paying off debt. It’s so important to clear the decks of as many expenses as possible in order to save large amounts of money, especially if you’ve never done it in the past.

Good job on your progress!

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Spedie 2010/12/30 at 8:55 am

Kevin, if only more people realized what we have then this country and world wouldn’t be in such a mess.

One day, we will sit on the beaches of the world and not have to worry about money any longer. I look forward to that day.

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