Why Is a Credit Score Important?

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I hate credit scores.

Well, maybe it isn’t the credit score that I hate. It’s the way we tend to think about them.

Over the years, I’ve heard countless friends, family, and readers mention their credit score like it’s the “be all, end all” of money management. Some wear it like a badge of honor, holding it up as if all others should be envious.

“My credit score is 760,” they say, acting as if we all should be envious of their enormous perceived wealth.

Others cringe at the thought of their score, believing it defines their entire financial existence. “My credit score is in the 500s,” they admit sheepishly, convinced that they’ll never be able to find solid financial footing ever again.

To both of them I say this: “Big deal.”

What Is A Credit Score?

Somewhere along the line, we’ve gotten the idea that credit scores are the greatest measure of financial stability there is. We’ve come to believe that a high credit score equals wealth and a low score can only be associated with those who are poor.

In short, we have twisted what the credit score actually means and forgotten what it truly measures.

Credit scores are a metric used and created by the banking industry to determine how well you handle debt. Banks use this score to help them determine if you are a worthy candidate for a loan. They want to know if you are a good bet and if they can make money off of you. Credit scores are nothing more, nothing less.

Now, having a good credit score doesn’t necessarily mean you’re wealthy – just like having low credit score doesn’t mean you are poor. Bill Gates could file chapter 13 bankruptcy, which would certainly destroy his credit score… but that doesn’t mean he’s broke. He still owns plenty of money and assets. He simply can’t pay his bills.

In the same way, Susie Smith might have a high score because she pays her bills on time. However, she could easily have a negative net worth because of all the money she owes.

Additionally, because of the way credit scores are determined, a multimillionaire could easily have a low credit score. Why? Because if you don’t use credit, your credit score suffers.

Again, credit scores measure how well you handle debt. They are not representative of a person’s wealth. Instead, they indicate how likely a lender is to make money from you. Period.

How Are Credit Scores Determined?

Speaking of measurements, here’s a quick refresher on how your credit score is calculated:

• Payment History (35%) – A whopping 35% of your credit score is determined by your payment history. So, if you’ve had trouble paying your bills on time, your score will certainly suffer.
• Credit Utilization (30%) – Credit utilization measures the amount of credit you are using compared to the amount of credit you have available. So, if you’ve got $10,000 in open credit, having balances totaling $3,000 gives you a credit utilization of 30%. Opening or closing lines of credit can affect this number. For the purposes of a credit score, the lower your credit utilization, the better.
• Length of Credit History (15%) – Creditors want to make sure you have a history of paying back your loans. Keeping an old credit card open, even if you never use it, can help keep your credit history looking good.
• Credit Mix (10%) – This part of your score accounts for the different types of credit you use. Things like credit cards, mortgages, auto loans, and more are considered.
• Recent Credit Activity (10%) – Here, recent credit applications are the most important factor. Several recent applications could be an indication of financial troubles.

At first glance, you might think that your credit score is a measure of your financial health… and it is, in a way. (It’s a measurement of how likely you are to repay your debt.) But if you dig a little deeper, you realize that you actually need to use debt in order to improve your score.

If you’re deeply in debt but pay your bills on time, you’ll probably have a pretty good credit score. However, if you don’t use credit cards or take out loans, you could be a billionaire but still have a bad credit score.

And, since we believe debt is the single biggest obstacle to building real wealth and creating a life you’ll love, is a credit score really a good measurement of your financial health?

In many ways, the answer is no.

7 Reasons You Should Care about Your Credit Score

So, I’ve spent the last 750 words or so railing against why I don’t particularly like credit scores. But, I am also a realist. Whether I like them or not, credit scores are here to stay. And, for the majority of people, credit scores are an important number to follow. Here’s why.

Credit scores directly affect your ability to get a loan. – Look, I absolutely despise debt and think you should avoid it at all costs. But, like I mentioned earlier, I’m a realist. Without a loan, buying a house is next to impossible for most people. I still think you should pay cash for your cars, but – quite frankly – I know most people won’t heed that advice. So, in most cases, having a good credit score is essential to saving money on some of life’s biggest purchases.

Credit scores affect your insurance rates. – Right or wrong, many insurance companies – particularly when it comes to car insurance – use your credit score when determining your rates. Insurance is expensive enough. Why make it worse by neglecting your credit score?

Your credit may affect your ability to land certain jobs. – Although your credit score isn’t used directly, having bad credit can keep you from landing certain jobs. This is particularly true for jobs in the financial sector but isn’t limited to that industry.

Your credit may affect your ability to rent a house or apartment. – Landlords use limited credit reports to screen renters all the time. As a landlord myself, this is one of the best tools I have for determining who will actually pay the rent. Again, credit scores aren’t used directly; however, they are a good indicator of whether your credit report has marks against it.

Sudden drops in your credit score can indicate identity theft. – Monitoring your credit score isn’t only a good idea when shopping for a loan. A sudden dip in your score could tip you off that somebody is using your identity to open fraudulent accounts. That alone should be enough reason to pay attention.

You need a good credit score to get the best rewards cards. – As a credit card rewards enthusiast, it’s important for me to keep a good credit score so that I have access to the best rewards cards. The best cards typically require a score of 720 or higher. My family has used rewards to travel the world for pennies on the dollar, which keeps having a good credit score near the top of my financial priorities list.

Bad credit scores mean you’re not taking care of business. – Wait? Didn’t I just spend most of this piece saying that a credit scores aren’t an indicator of financial strength? Yes… but again, I’m a realist. Most people aren’t millionaires. Most people have loads of debt. In the vast majority of cases, a bad credit score means you’re not paying your bills. If that’s the case, use your score as motivation to turn your fortunes around and start taking care of business.

Where Can I Get a Free Credit Score?

To make sure you’re on the right track, you can monitor your credit score through a free platform like Credit Sesame. I’ve used them for years, and absolutely love them. They send monthly updates on my score, plus I receive updates whenever a new account is opened in my name, helping me to spot any signs of identity theft early.

If your score isn’t as high as you think it should be, make sure you comb through your actual credit reports to look for errors. The credit reporting bureaus are also required to provide a free copy of your credit report every 12 months, and even if your score is good, it’s still important to give these reports a look. You can request your free annual credit reports here.

Final Thoughts

Yes, I still hate the credit score. Yes, I’m probably always going to hate it – especially the way we think about it. Still, I understand that monitoring your credit score is important.

By maintaining a good credit score, you’ll be able to get the best rates on loans and insurance, potentially saving you thousands of dollars over the years. As importantly, should it ever happen, you’ll be able to spot identity theft quickly and stop it before it spirals out of hand.

And, since you can get a free credit score almost everywhere, that alone is worth watching.