Economics, For the Record

High credit scores aren’t exactly what you think. Here’s the truth.

By Lynn Pierce

Establishing and maintaining a respectable credit score could be the biggest pitfall for a successful financial future.

A recent report from Experian revealed the average FICO score in America reached an all-time high in 2019 at 703. You might think that the news of high credit scores is a positive trend: more people taking due diligence to maintain a respectable credit score, therefore, becoming better off financially. However, that’s not necessarily the case, as debt balances have increased and Americans still suffer from a lack of savings.

More consumers appear to be following an Iranian Proverb, “Credit is better than wealth,” and disregarding that credit and credit scores are not necessarily designed for consumers. They favor creditors.

“FICO scores strictly show credit worthiness to a creditor,” said Doug Overbey, a financial advisor with First Command. “It doesn’t determine your ability to save, invest or obtain a good financial future.”

The pursuit of a favorable credit score to secure commercial loans for our cars and homes has been viewed as a necessary evil. That’s understandable but it lacks the proper context.

According to Experian, amassing various amounts of debt for a time period is necessary to reach a good to excellent FICO score. Mike McNamara, a credit expert with Southern Trust Mortgage, said in an interview that some amount of  debt is also needed to improve a credit score.

“You will probably need two to three accounts opened for at least six months,” he said. The credit bureaus  “like to see activity.”

Without debt, there is simply no way to improve a credit score. For consumers, this is the risk versus the reward.

A consumer can accumulate debt for a period of time to validate their credit worthiness, but the credit score boost isn’t always significant or  worth it. That’s the case especially when you include interest charges and fees if the credit balance isn’t paid in full.

A Bankrate study showed two-thirds of people with credit cards owe at least as much now as they have over the past decade. This is evidence of how long it may take to pay off credit balances, particularly credit cards, and how rarely people actually do it.

Another study conducted in 2017 by the Consumer Financial Protection Bureau found that people with higher credit scores continued to account for the majority of credit card debt. The study also found consumers with the higher credit scores accounted for the majority of credit card spending. Consumers used their credit cards more frequently because of reward programs and fewer fees. In both studies, the consumers do benefit, but  to a lesser degree than creditors.

Dave Ramsey, author of “The Total Money Makeover,” takes an extreme view of credit, suggesting that high FICO scores are an “’I love debt’ score and ‘I am really good at borrowing and paying back a lot of debt over a long period of time’ score.” Realistically, very few people would subscribe to this philosophy.

McNamara recommended a simpler approach. “Keep the two to three balances open with very low balances, like a credit card, because if you don’t have any debt, especially for a period of time, your credit score will drop.”

This  approach seems reasonable, except data shows that when people have credit cards, they tend to overuse them. Credit cards are as much revolving traps as they are revolving credit.

The best answer appears to be changing the way we think about credit scores.

Truth be told, a high FICO score should not be viewed as a prize or a goal to pursue in and of itself. It benefits creditors, not the consumer. That’s because there is a significant correlation between good credit scores and debt. More debt means more payments, which could limit a person’s ability to build a successful financial future.

In that context, respectable FICO scores should be an afterthought, only used when needed for commercial credit, as part of a calculated budget that focuses on securing a better financial tomorrow.

March 3, 2020

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