One of the first things you are faced with when you start becoming financially independent in your life is the reality of your credit score.
First things first, what is a credit score?
Wikipedia defines a credit score as a number representing the creditworthiness of a person, the likelihood that person will pay his or her debts. Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk posed by lending money to consumers. Widespread use of credit scores has made credit more widely available and cheaper for consumers.
Investopedia gives the following definition and explanation: A statistically derived numeric expression of a person’s creditworthiness that is used by lenders to access the likelihood that a person will repay his or her debts. A credit score is based on, among other things, a person’s past credit history. It is a number between 300 and 850 – the higher the number, the more creditworthy the person is deemed to be. A FICO score is the most widely used credit scoring system. FICO is an acronym for Fair Isaac Corporation, the company that provides the credit score model to financial institutions. There are other providers of credit scoring systems as well. Consumers can typically keep their credit scores high by maintaining a long history of always paying their bills on time and not having too much debt. A credit score plays a large role in a lender’s decision to extend credit and under what terms. For example, borrowers with a credit score that is under 600 will be unable to receive a prime mortgage and will typically need to go to a subprime lender for a subprime mortgage, which will typically have a higher interest rate.
That all sounds great, but what if I told you that your credit score does not make or break you financially? There are many people who will tell you that you can’t make it in life without a good credit score. Certainly, life might be easier with a high credit score, but you can still be OK without a high score.
Today I want to give you three myths about your credit score and tell you why these myths are not true.
Your credit score is an indication of your financial success.
This is simply not true. Your credit score (also called your FICO score as we read above) tells you one things: how well you manage debt. It’s all about debt. It indicates how much debt you’ve gone into, what kind of debt you have, how consistently you’ve used and paid on debt, and those sort of things. The best indicator of your financial success is your bank account, not your credit score.
You need a credit score to rent an apartment.
This one is not true either. If you have your first and last month’s rent plus a security deposit, a majority of apartment complexes will work with you. You might have to try two or three, but they are out there.
Keeping a credit score to secure low rates on car insurance is a smart move.
It is true that no credit score, or a bad credit score, can drive up rates on your car insurance. But you will more than make up for that with all the money you will save by not paying interest to a bank in an effort to build your credit score.
The point is that the sooner you begin paying with cash, avoiding debt, and staying away from the credit score trap, the better off you will be in the long run.