Certain personal finance gurus such as Dave Ramsey argue that you can (and should) ignore your FICO credit score. Others, like Suze Orman, advocate taking control of your score. So who is right?
Given how often credit scores are talked about in various books and on TV, I wanted to dig deeper and see how much impact your credit score can have on your life.
What is a FICO credit score?
Fair Isaac and Company (FICO) has developed a system to help creditors determine a person’s credit risk based on their credit history. Lenders rely on these scores when determining whether or not they should lend to a prospective borrower.
You may be surprised to learn that you actually have three scores instead of just one. That’s because each credit bureau can generate their own score for you based on the information that they have. What is my credit score?
How is your FICO credit score calculated?
Your FICO score is determined by what’s in your credit report. While the exact formula is a secret, here are the factors that affect your credit score and approximately how much weight is given to each.
- Payment history – 35%
- Amounts owed – 30%
- Length of credit history – 15%
- New credit – 10%
- Types of credit used – 10%
What’s frustrating with this formula is that your credit score can actually decrease if you make a financially sound decision, like paying off debt.
For example, Nickel discovered his credit score went down when he paid off his mortgage. I also saw my score drop by seven points when we paid off my car loan.
While there are various opinions on what constitutes a good FICO score, a score of 760 or above is generally enough for you to get approved for a loan at a favorable rate.
Who uses FICO scores?
So when does your credit score actually come into play? If you’re applying a loan, your credit score will almost certainly play a role in your approval. Your score can also play a role in determining the interest rate you’re offered.
While some mortgage lenders do “manual underwriting, ” they are in the minority. That being said, Dave Ramsey advocates using this sort of lender in his Total Money Makeover program.
Aside from lenders, it’s important to know that other companies are starting to look at your credit scores. They include:
- Car insurance – Did you know that your score can affect your car insurance premiums?
- Landlords – Depending on where you’re looking to live, some landlords are running credit checks to protect themselves from bad tenants.
- Potential employers – Like landlords, some employers see credit scores as an indication of a candidate’s reliability.
- Utilities – Some companies use your credit score to determine if you need to put down a security deposit.
- Banks – Many banks, both online and local, will check your score before opening an account – especially if you are applying for overdraft protection.
While you may not be crazy about the many ways in which your credit score can influence your personal finance, it definitely pays to stay on top of it. Check what you can do to help your credit score.
Maintaining a good score without debt
Dave Ramsey has commented that if you avoid debt, then your score will go down to zero. While Dave may not care about his credit score, the fact is that your credit score can impact various facets of your life. But is it necessary to carry debt to maintain a decent credit score? Not necessarily.
You should never borrow money just to build your credit score. Likewise, you shouldn’t carry a balance on your credit card in hopes that it will boost your score. To maintain a decent score, simply keep an eye on your limits and always make your payments on time.
Credit scores are really just a snapshot of your financial life, and much of the information is drawn from recent statements. If you max out a credit line shortly before applying for a loan, that can negatively impact your credit score even if you intend to pay it off in full.
That’s one of the big problems with credit scores – they don’t necessarily reflect your long-term financial health.
Thoughts on credit scores
It surprises me a bit to see how much your credit score can affect your daily life. We’re not doing anything special to manage our scores, but they are important to us.
My husband and I have a single credit account that we use occasionally, but we pay it off in full every month. We also have a mortgage that we’ll probably have for another 15 years based on current payments.
How important is your credit score to you? Have you done anything special to improve or maintain your credit score? Have you ever had any problems getting a loan or in other areas due to a low score?
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I don’t know who Dave is but I have a few questions since alot of you seem knowledgable on the subject of credit. Please answer the questions as if they are independent of eachother because I am looking at some options.
How long does it take for a FICO credit score to regain stability after a new credit line is established assuming all other factors remain constant (good standing)?
How many points on a FICO score does a new credit line set one back before the points begin to stablize?
How long does it take for a FICO credit score to regain stability after debt is paid down to 20% from 75% assuming all other factors remain constant (good standing)?
Is ones credit affected more negatively if you are paying more than the credit card company requests/period than paying the exact amount the credit card company requests/period assuming all other factors remain constant (good standing)?
How many points does a request of loan set one back for the FICO score and for how long?
Please advise and thank you,
Tiffiany
I am not a fan of Dave Ramsey really, and I agree with the #10 comment by Nickel. Ramsey is rich because he learned to market.
I think much of his advice is unrealistic, and many of his listeners (probably all) will never be able to pay cash for a house.
I truly believe not paying attention to your credit score is a big mistake BUT nobody ever said having a good credit score means you have to be in debt.
Here’s the real problem:
Maintaining a decent score when you already have a good one and make a good living isn’t that tough. The real problem is when hard working people who have typically maintained decent credit/debt levels slip due to unforeseen circumstances. Finding their way back seems to be the hard part.
Jeff) the federal government has a debt of $14 trillion currently. High, but nowhere near that $100 trillion figure you cite. I think you are including “future obligations” should Congress not change anything — and of course, congress changes things all the time.
In times of high inflation, fixed-rate debt is your friend. That’s why the Fed and US Government are creating inflation… We have more debt than that we’ll never be able to pay off, (around $100 Trillion), so the only real option is to devalue the currency through inflation, reducing the potency of the debt in the process.
I’ve never gone back and calculated it, but I know I’ve saved thousands over the years by having a great score. I’ve always been granted the best rate for my mortgage, a car loan and never paid a dime in high interest debt (credit card, etc). Paying 0.9% on a car? Fine by me, when I was earning more in a CD.
#5 Patrick) Exactly, the FICO score does not take into account your income. Personally, I think FICO scores are pretty much useless because of that.
You can be in debt up to your eyeballs, and still have a high FICO score (as long as the debt is all payed on time). Compared to a billionaire with no debt accounts, and no credit history: likely has a low credit score.
The “Debt-to-Income” ratio is key, but the history of making payments on time is a factor too. I can’t believe the car dealership put the car in your wife’s name when she has zero-income!
Dawn: Dave isn’t rich because he eschewed FICO scores on a personal level. Dave is rich because he did a fantastic job of packaging that message and selling it.
Actually most people posting on here don’t have much debt. Dave doesn’t care for FICO because he allowed it to ruin his life by being irresponsible with debt in the first place. Like I said, I don’t use my credit cards which means i have no debt and will pay less for insurance, so I get a double prize because the reality is that many look at your score. Dave helps others that are just like him, irresponsible with debt, so something to keep in mind before you drink his kool-aid.
I’d rather be smart than weird any day.
Sounds like the everyone posting is A-OK with being NORMAL.
Dave Ramsey is rich because he has followed the principles of the rich (see: The Millionaire Next Door/Stop Acting Rich by Thomas J. Stanley). He started with nothing, and after bankruptcy, built his wealth back up by paying with cash and not worrying about FICO.
He does not need FICO because he is rich; he doesn’t need FICO because he saved up over several years and bought things outright. It’s called delayed gratification. NORMAL people seem to have trouble with that. Yay for mediocrity!
Also, he mentions that after your score disappears you may have to pay deposits for accounts that require a FICO, but that’s hardly a huge cost when it comes down to the financial raping done by banks, credit cards and other lenders. By not borrowing, you always come out ahead regardless of increased rates elsewhere (like insurance). Interest is much more costly in the long run. Not to mention that you spend more when using plastic because there is no ouch factor.
Regarding employment: unless you want to work directly with company cash or want a low paying Home Depot gig, most places who hire knowledge workers don’t check FICO. Besides who wants a job where all they base their hiring on is a credit score? If that’s the only element that they are judging you against, that company has its priorities completely out of whack. Sorry, I’d start my own business before I worked with the likes of them.
Overall, everyone is so dramatic with OMG need FICO; pray at the altar of the great FICO. YAWN.
Lastly, Suze Orman has no credibility because she’s paid to endorse FICO. Durr… big conflict of interest there.
I’m debt free, credit card free and weird! Can’t wait until my FICO goes away completely. 🙂 It will be a day of celebration!
Less focus on scores and more focus on the amount of debt your taking out. Regardless of your current score, debt in the end can cause it to go bad very quickly. I haven’t used my credit cards in over 6 years, because there really is no need to use them. I only have them for score image only, that’s it. Insurance companies have no business using your score in the first place. I do agree with Dave Ramsey on that topic. They use it to make more money and that is it. Its pretty damn sad they are even allowed to look at it because insurance is not debt nor linked to anything at all about risk of claims or accidents.
I find Dave Ramsey very legalistic, however the little I know about his history and listening to a few shows, I’ve concluded it’s like 12-step program (only there are 7) for those who struggle with debt as others might with alcohol. I’m certainly not a “tea toddler” but want to be the kind of person who is a ‘cheerleader’ for anyone in AA. In that light, I’ll reserve any comment on what has helped many who’ve ended up in some pretty deep monetary messes.
One of my “book/radio” mentors, Dave also lists as one of his, Larry Burkett, had a great article delineating the difference between “debt” and “credit.” While often credit can lead to debt, not the same. I am nearly debt-free (converted the last of my mortgage to HELOC, so that’s the “nearly”) but I use credit frequently.
I think a good FICO score is important, mostly as I do good insurance policy, not desiring to need it (just because folks are willing to give you “enough rope” doesn’t mean you have to use it). Other than ensure bills are paid, I use the credit card with the “worst terms” as a ax over me head to ensure it’s paid off also because it is the oldest, so good to keep around in relationship to FICO.
I have had some odd issues with credit scores in that my wifes score is higher than mine even though she has been a housewife for the last 12 years and has not held a job or paid a single dollar in taxes since the late 1990’s.
A few years ago we got a credit card in her name for her to use while I was deployed. She made the payments each month, never letting the balance get over $100 and when I came home we paid it off.
Last year I went to the car dealership to get a car and after they ran both reports the sales rep came and said it would be better to put the car in her name to qualify for the 0.9% interest rate. This is after I showed them my pay stubs and we told them that she had no income. Amazingly enough no matter what I do her score is always a few points higher than mine, which still baffles me since anyone who actually looked into our financial situation would find out that she couldn’t make the payments without me.
I agree that old Dave Ramsey doesn’t need a credit score because he can pay cash for absolutely anything he could ever dream of, even a massive new house! But for the rest of us, we do need our credit score to get mortgages and take out car loans. I pay my credit card off each month so my credit score remains high if I ever need it. I also opted out of paying a $600 deposit on my natural gas hookup because my credit score was high enough. Not a bad deal…
I hear from so many people worry about their credit score when they have debt. That’s the wrong approach – if you have debt, you should worry about getting out of debt first. Credit scores are for borrowing money, and you shouldn’t focus on borrowing when you are paying off debt. And if you’ve never had debt or payment issues, then your score should be fine. Way overrated topic for most people.
Dave Ramsey does not worry about his FICO score because he does not have to. He is wealthy, and given his notoriety re: debt I doubt that he would have much problem qualifying for the best insurance rates, get his utilities turned on, etc. Most of the rest of us do not have his level of wealth nor his notoriety, so it is different for us. While I agree with Dave that we should not be obsessed with FICO nor even seek to actively manage it, the reality is that in order for most of us to effectively function in the world we at least need to be aware of it and how our actions impact the overall score. Historically we have carried no debt except for the mortgage on a vacation home, however a few weeks ago I had to purchase a new vehicle after totalling my existing vehicle. I went looking for a good used vehicle but the deals offered on new vehicles at the end of the year compelled me to condsider buying new (really against my philosophy). One of the deals was a $3K discount on the vehicle from GM if I financed the vehicle with their affiliate, Ally Financial (this is also really goes against my philosophy). With no prepayment penalties in the contract I decided to do it and applied for credit where I learned that my score was 812 qualifying me for the “best” financing deal. I will pay off the vehicle with the first payment, but my experience reinforced that prudent managment of credit will provide you with a “good” score, and that most of us benefit from having that good score.
We pay all bills on time, pay credit cards off in full every month, and rarely apply for new credit: credit score is 815+ for the spouse and I.
Having said that, statistics say that most people have a few errors in their credit reports. So if you are struggling with an ‘undeserved’ low credit score, go through your credit reports looking for errors and dispute them through the formal process.
If your low score is ‘deserved’, then start playing by the rules, and over time your score will improve.