Almost every day, I (guest host Jeremy Schneider) hear someone mention their credit score.
After being in school our entire young lives, we must all crave for someone to give us another grade.
And when the ol’ FICO corporation is slapping a big number on all of us…
…we excitedly spend every waking moment trying to improve (or maintain) it.
But here’s the problem: Focusing on your credit score is a TERRIBLE way to win with money.
You’re putting your energy towards precisely the wrong thing.
In today’s episode, I’m sharing why you shouldn’t care about your credit score + what you should be focusing on instead!
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- Jeremy Schneider:
- Who cares about your credit score? Know your NET WORTH SCORE!
- Credit Score Components
- How to Check Your Credit Score and Monitor Your Credit for Free
- Cyber Security: Everything You Need to Know to Stay Safe Online
- Financial Scam Alert + Three Ways to Protect Your Loved Ones
- How to Freeze Your Credit
Why You Shouldn't Care About Your Credit Score
Jeremy Schneider: Welcome to the Stay Wealthy podcast with Taylor Schulte. I'm your guest host Jeremy Schneider, filling in for Taylor for the month of August.
Today I'll be discussing net worth and credit scores. Specifically I'm sharing what are they and how do you calculate them? Comparing which one is more important to your financial health and why optimizing your credit score may be hurting you.
If you have wondered how you stack up financially and want to improve these numbers, today's episode is for you. For all the links and resources mentioned in today's episode, head over to youstaywealthy.com/196.
This is the third of four shows I’m filling in for Taylor. He'll be back in September. So if you are sick of hearing me, my reign is almost over, but bear with me.
Today we're discussing two very popular financial metrics, credit score and net worth. And I know as a Taylor Schulte listener and a Stay Wealthy podcast listener, you are probably quite financially savvy and you probably know what these are, but I think it's important to dig in and really understand how they're calculated and some of the psychology that goes on behind them because they can play some tricks on us that can hurt us financially.
So let's start with a credit score. What is a credit score? Well, it's a number that ranges from 300 to 850 that basically represents the likelihood that you are going to pay your bills back over time. There are three credit bureaus out there, Experian, Equifax, and TransUnion that basically track all of your debt and repayment transactions, credit cards, mortgages, car loans, things of that nature.
And based on those transactions over long periods of time, they create this credit score of that range, 300 to 850. The extreme parts of that range aren't generally used much. You don't really find someone with an 850 or a 300 credit score. Anything over 740 is generally considered very good and the benefits of having a higher than 740 credit score are kind of diminishing beyond that. Once you're in the very good range, you're going to be fine, but let's talk about how it's calculated.
There are basically five main factors that go into your credit score. The biggest representing 35% of your credit score is your payment history. That basically means have you been paying your bills on time, have you been paying off your loans or have you not been paying off your bills? And if you're trying to create a metric that predicts if you're going to pay off your bills, have you paid them off in the past is a pretty good indicator.
The second representing 30% of the credit score is the amounts owed. So if all your credit cards are maxed out and you're borrowing more and more money, that's going to hurt your credit score. If you have a lot of room underneath your credit card limit, that's going to help your credit score.
The next feature is representing 15% of your credit score is length of credit history. If you open up your very first credit card a week ago and there's very little data to go off of, even if you've never missed a payment, that's still not going to be a great credit score because there's not a lot of history there.
So 15% represent the length of credit history, the longer the better, and this is usually calculated as the average length of credit history. So if you have one very old card and then you open up a new credit card, for example, that could actually cut your credit history in half because now your average credit history might've gone from 10 years to five years.
If you have a 10-year-old card and a brand new card, the next representing 10% of your credit score is credit mix or number of accounts. If you just have one bank or one car loan and that's the only time you've ever borrowed money and you've never had a credit card, you've never had a mortgage, you've never had a student loan, anything like that, again, it's kind of less data for the credit bureaus to go off of to give you a score.
But keep in mind though, that's only 10%, obviously the biggest chunk is still heavy made payments in the past, and then the last 10% is new credit inquiries. If you apply for a whole bunch of new loans all at once, that can actually hurt your score because it might indicate that you are about to get in over your head with debt or about to skip the country or something like that. Actually applying for new loans temporarily decreases your score.
So all this combined, basically how you've been using debt and making payments over time results in the score between 300 and 850. Then how is this used?
Primarily it's used by banks and lenders who are going to offer you lines of credit like a mortgage or a loan or a credit card, and it can affect whether or not you're approved and it can affect what rate you receive.
So for example, if you apply for a mortgage, the mortgages are obviously very, very big loans, and so they look at more than just a credit score. They look at your income and your other debts and all sorts of things in your financial life, but your credit score could impact the rate that you pay more and more.
Credit scores also can be used by non purely lender purposes. Things like apartment applications or job applications or even rates for auto or other types of insurance, those organizations can look at your credit score to basically find out if you are a generally upstanding citizen.
And so based on all this, as much as I'm not a huge fan of bearing yourself in debt because I'm not maintaining a solid credit score is kind of a reality of participating in the modern American economy.
Alright, that's credit score. Now let's talk about net worth because we're going to compare and contrast credit score net worth because these are kind of competing financial metrics in my opinion, and there's often misplaced focus on the two of them.
So let's talk about net worth. Net worth is a relatively simple metric. It basically means how much money you have, and net means it's the net of all of your assets minus all of your debts. So it's what you own minus what you owe.
So for example, if you have a hundred thousand dollars in cash in your bank account and you have no debt to your name, not a credit card, not a student loan, not a car loan, not anything, and assuming you have a very simple financial life and don't own anything else, your net worth would be a hundred thousand dollars.
But let's say you have a hundred thousand in the bank and a $50,000 student loan, then your net worth would be that $100,000 of asset minus the $50,000 of debt for a net worth of positive $50,000. Sometimes people get confused about the debt portion specifically on home ownership.
So let's say you have that very simple life where you have a hundred thousand dollars and zero debt and you decide to buy a house that's $500,000 and you put every penny to your name into the down payment. So you make that $100,000 down payment to the house and you take on a $400,000 mortgage. How does that impact your net worth?
You can guess to yourself as you're driving in your car or otherwise listening to the podcast. The answer is, other than some fees and stuff associated with the cost of buying a home, it doesn't impact your net worth. Your net worth stays the same if you went from having a hundred thousand dollars in cash to zero in cash, but instead you own a 500,000 home, your asset is $500,000 and your liability, your debt is negative $400,000.
So 500,000 minus 400,000, your home minus the mortgage equals a hundred thousand dollars. So even though you're converting all that cash into this real estate, your net worth stays the same because you're acquiring an asset for 500 and you're acquiring a debt for 400, meaning you still have the a hundred thousand dollars.
So that's your net worth and net worth. It's not a strictly tracked metric. There's no one out there that's really keeping track of your net worth other than you, but I think it's good to know your net worth because it's really the score.
It's really if you're trying to build wealth, if you're listening to the Stay Wealthy podcast and we can ascribe one number to what is wealthy, it's your net worth. It's not your credit score. It's not how much cash in your check account, it's not what your home is worth. It's not what car you drive, it's your net worth. It's everything you own minus everything you owe.
So in the US, we have an obsession with credit scores. I don't really know why. I theorize it's because we all grew up in the educational system. We went to school, most of us for at least 12 years, elementary school through high school, many of us through college and beyond. And for the entirety of our formative years of being on this earth, we were given grades and we were trained to get better grades.
That was our whole purpose of being during these most formative years of our life. And then when we entered adulthood and we found out that there's a big governing body, FICO and the credit bureaus who are all watching us and giving us a score, I just think we kind of revert to our training, which is we must get the best score possible and we get obsessed with it.
When I'm doing live events and I talk to groups of either college kids or young adults or whatever it is, ask a trivia question. I said, raise your hand. And I say, what would you rather have? It's like, would you rather have an 800 credit score, which is an excellent credit score? Well above that 740 I mentioned earlier, or would you rather have a million dollars in cash?
When I ask this question, usually more people raise their hand for the credit score, and that's bananas. And I just think because we're just trained to live in this debt-focused world where you have to have a good score and you're being grilled.
But to illustrate how absurd that is, if you had a million dollars in cash, you could go put it into a bank account and call that bank account, pretend bank or fictional bank, and then every time that you would need to use a credit score for something like applying for an apartment or borrowing money for a car or a credit card or anything like that, you could just simply not apply for any of that debt to just take money out of your secondary bank account there, put it into your checking account, and then make payments back to yourself.
With cash, it literally eliminates basically the entire need for a credit score. Plus, instead of making debt payments over and over and over at the cost of the current rate of return and all that, you're actually getting interest and you're paying yourself back.
And so being positive, having a positive net worth having a lot of cash is dramatically better than having a good credit score. I also often ask, which number do people know? I say, Hey, who knows what their credit score is and who knows what their net worth score is? And I say, net worth score because I think if we add the word score to it, it makes it a little more fun. And then we're like, Ooh, it's a score and it's like getting an A in school was, and so let's call it net worth score from now on, and then we're all going to hopefully get better scores.
When I ask that question, usually 80 to 90% of people know approximately their credit score and maybe a quarter or so know their net worth. And so even though net worth is dramatically more important, fewer people are carefully tracking it, and instead, this focus is on the credit score.
And so I'm going to make a proclamation right here on the Stay Wealthy Podcast. Your net worth is dramatically more important than your credit score. Let's look at why a credit score is designed to make banks rich.
That's why credit scores exist. It's for banks to not lose money by lending money to people who aren't going to pay it back. It's not designed to help the consumer. It's literally a tool used by banks to increase their profitability. That's why credit scores exist.
Net worth is the definition of you being rich. So credit scores make banks rich. Net worth is the person being rich, which one's more important? Net worth credit score puts focus on debt and being in debt. That's what a credit score is. It's about how much debt you take out and how much you pay it back.
It's this revolving door of borrowing and repayment. Net worth puts your focus on building wealth net worth, again is what you own, minus what you owe. So your higher net worth is the more wealth you have.
So again, credit score, focus on debt negatives, net worth, focus on wealth positive. Again, which one's better? Net worth credit score encourages overspending. The way the credit score is calculated is borrowing money, getting higher credit limits, paying it back more, getting more credit mix longer loans, all this stuff. It encourages spending. It's all about spending net worth, encourages frugality by having fewer liabilities and having that results in a higher net worth.
And again, credit score encourages spending net worth, encourages, frugality. All of these things are almost opposites. They're almost counter to each other where credit score is keeping you broke. And a net worth is the definition of being rich. And so that's why I think it's so much more important to focus on your net worth, not your credit score.
If you are still worried about your credit score, you're like, oh man, I really want that good grade. They're out there watching. I want a good number. Maybe you're tempted to keep loans around to improve your score, or even worse at borrow more money to get the score.
I'll tell you what I do. I looked it up about 20 minutes ago. My credit score is currently 803 according to creditkarma.com, by the way, creditkarma.com. It's a free website. You can log in, there's no impact on your score by checking it, and it basically tells you every single day what your credit score is.
I don't necessarily think you should check it every single day, maybe once every six months or once a year or something just to make sure nothing crazy is happening, but there's one option for checking it for free.
So I have an 803, which is in the excellent range. There's not really any range above 800 that is even tracked. And here's my debt history. It's very, very simple, so I can say it to you all right. Now, I have never had a mortgage in my entire life, strangely. I applied for a mortgage once when I bought the house I currently live in, and my net worth at the time was about $3.8 million. And I had a credit score of about 800, and I was denied.
So I had this phenomenal credit score, a phenomenal net worth, and the mortgage company denied me for any loan. The reason because I didn't have a job, strangely, I retired when I was 36 years old, I'm now 42. They saw no typical W2 income on my tax returns, things like that.
Instead, my wealth now is from investing and creating businesses and things of that sort. And so the mortgage company just didn't fit into their box. They didn't offer me a loan, so I just bought my $700,000 home in cash. It was fine. It's great because now I don't have to make payments to the bank, and it just shows where bankers incentives are.
So back to my credit score, I've never had a mortgage. Only one time in my entire life have I borrowed money for a car. It was about a three-year period in my mid-twenties, and that was paid off about 15 years ago. I borrowed $5,000 and paid it off over the course of three years.
I've never had any other loans outside of credit cards. So I've never had student loans, thankfully. Medical loans, personal loans, HELOCs, the only thing on my credit score ever was a three-year auto loan 15 years ago. And exactly two credit cards, I keep two credit cards.
The first credit card I keep is my oldest card because length of credit history calculates into your credit score. I never close my oldest card. And on that oldest card, I put all of my recurring expenses. So things like Netflix, utilities, if you can get away with it, insurance, anything that is just going to hit your credit card once a month, I put it on that card.
And then I never use that card for any ongoing transactions or any transactional payments. The reason is, every time you're swiping your card at a gas station or handing it to someone at a restaurant or paying for something online, it increases slightly the risk that card's going to get stolen.
And if that card gets stolen, it just creates a logistical nightmare to go and update the credit card number on all of your recurring payments. So if a card's going to get stolen, I want my other card to get stolen. So my oldest card, I don't need to mess with it. So that's the first card.
And the second card that I keep is my favorite card. Whatever I want for cash back or miles or points or whatever it is, and I'm not a big points guy. I think the credit card points game is this creation of these billion-dollar credit card companies to basically trick people into spending more and staying broke.
And I know the arguments for points, it's like if you're going to spend the money anyway, you might as well get points. Yeah, I get that. But they've done so many studies that look at the psychological effects of this, and people always spend more money with credit cards than when they use cash.
And so it's like once the points are kind of seeped into your subconscious, it can affect your spending. And if it affects your spending even by one or 2%, it totally invalidates any of the benefit of points.
So that said, I'm a realist. If I'm going to have a card, I might as well get the points and just try to not let it affect me. But those are my two cards, my oldest card and my favorite card, and that's how I use them. And then all I do is I pay off both my cards in full every single month. I have them both on autopay, so I don't have to even remember.
And so now for the last, I'm 42 years old now for my entire adult life, essentially minus some little bit of mess in my twenties as many of us have. I've just been making my payments on time and the result, an 803 credit score.
I'm not bragging about my credit score. I don't even pull it as a badge of honor. It's just an example of you don't need to be really working on a big mix of credit. Like, Ooh, I should have a bunch of different loans to impress the credit score in Gods. Don't do that. Just pay your bills on time, keep it simple.
Stay the course for a long period of time. Your credit score will be fine, and then don't focus on anymore. So with such a simple debt history, why my credit scores go high, well, let's look at those five aspects of it.
Again, number one, payments on time, 35%. I basically have never made a late payment in 20 years, so there you go. I'm likely to pay back bills. Two, I pay in full every month, so I have a very low amount owed. I do have pretty high limits now. I have high income. So I think the combined limits of my two credit cards are 30 or $40,000 or something like that.
And every month I put a few thousand bucks and pay off in full. And so I never have a high credit utilization. I also have a very long credit history. Now, my oldest card, I think has been open probably 15, 20 years or something like that. And so my credit history is very long.
I have very few new inquiries because I'm not applying for new loans all the time. Therefore, that aspect of my card is good. And the one feature of the FI that works against me is my credit mix. I don't have a lot of loans. I have a lot of different loans. I don't have a mortgage, a car loan. If I had those things and pay them off, my credit score would go up.
But who cares? My credit score is 800. It's totally fine. I don't want my credit score to go up. I want my net worth to go up. And my net worth, by the way, today after I bought that home in cash a few years ago, now it's about $4.8 million at the time of this recording. And so while my credit score is fine, there's no end to that. There's no end to chasing a better credit score.
But while a credit score stops at 850, as you probably know, there's no maximum to net worth. You can have infinite money if you can find it on this earth. So that is where your focus should be.
So in conclusion, maintaining a decent credit score is a reality of operating in the us. I'm not suggesting to burn your credit or don't pay attention to it. It's a good idea to keep an eye on your credit score, on your credit history.
But beyond that, anything over a 740 or so won't do much for you. You're going to get the best rates. You're going to get approved. I didn't, but it wasn't because of my credit scores because I had no income. And so obviously credit score isn't an ace in hole. But yeah, anything over seven 40 isn't going to do much for you.
There's limited returns after that, diminishing returns. And just do a few minimum best practices. Pay your bills on time, keep your oldest credit card open, but otherwise, don't focus on it. Do focus on saving and investing, lowering your expenses, increasing your income, investing the difference.
That's how you increase your net worth, not by playing the game of banks, not by this rotating door of getting in and out of debt. It's by spending less, earning more, investing. The difference, as I say, always with my two rules of personal finance club.
Rule number one is to live below your means, spend less money than you make. And rule number two is invest early and often. That's how you increase your net worth. That's how you get rich.
That is all I've got for you today. For all the links and resources mentioned in today's episode, head over to youstaywealthy.com/196.
Next week will be my fourth of four weeks. I'm filling in for Taylor, and he'll be back in September. I will see you then.
Episode Disclaimer: This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.