It’s very interesting to think about, how systems that we impose on ourselves can incentivize one to spend negatively. Why would we create a system that encourages one to go deeper into debt just so one could get a higher score? It’s the same thing as encouraging someone with an overeating disorder to go to all you can eat buffets every night of the week and giving them coupons in the process. Only one side wins. The systems that we create curbs customer behavior which can help or hurt individuals significantly in their lives. Therefore it is so important for who we decide the game makers to be.
I am relatively good at tracking my credit scores with Credit Karma (One of my favorite apps on my phone) because I am genuinely interested in seeing how my credit is trending on a month over month basis! With Credit Karma, I realized Experian isn’t reported (Only Equifax and Transunion). I immediately checked to see what my score was with Experian and I was shocked to find it was significantly lower than it was on the other credit reporting agencies. As many of you may know, over the past couple of years I was able to get completely out of installment debt and this is something I value above all else. One of the points being looked at favorably with this FICO Score 8 and 9 are having a non-mortgage installment loan (or credit mix).
This is ludicrous and is something I frown upon highly. The people in charge of the system want you to get into debt so you can get a higher credit score. I find this to be a guaranteed path to never achieving a high net worth, financial freedom and making payments for the rest of one’s life. If you needed to take out the auto loan to get to work and you had no cash, or you needed a personal loan because your water heater broke then I would say go for it. But, doing it just to get a higher score doesn’t make any sense and in fact, I think it is seriously damaging many consumers because they want to achieve a high score and sacrifice their net worth to do so. You are robbing yourself.
The newer scoring model called FICO 10 will release at the end of this year and it will bring some positive changes. The newer model is more risk-averse and looks at how individuals have managed their credit accounts over two years. By doing this, they can see how a person’s spending behavior is trending over time. Is their utilization rate increasing 10% every single month, or are they starting to carry over larger balances? Instead of having a snapshot view like we have now, a long term view is put into place and this helps assess one’s credit picture more holistically. The next thing I am looking forward to is that personal loans are punished much more. Isn’t that crazy? FICO 8 and 9 are out here encouraging you to add installment or personal loans to your mix, whereas FICO 10 it is a ding against you. This is actually what I like to see on the model, but something to note is that this model is always susceptible to change. All the score is, is a combination of algorithms that have been created by humans. One year what may be looked at as a good thing to one’s score, the next year may not be looked at as favorably. Something to note about FICO 10 is that you will either be helped significantly or brought down significantly. Essentially, more weight is being assigned to not increasing your debt, keeping a low utilization rate and not revolving personal loans. Simply, keep your expenses low, don’t exceed 10% spend of your credit limit and never carry a balance (in fact pay the card down before the statement date to get a better utilization rate). You have until the end of the year to prepare and build the best situation for yourself possible before the new scoring system rolls out.
In the end, I think we simply need to look at our credit as a tool that is there to help us, rather than something we actively work toward improving as a number. The model is always changing, but the principles behind debt management are timeless and remain the same. Be timely with your payments, don’t overextend borrowing and have an impeccable track record. You will be able to get favorable interest rates on mortgages in the future and any other creditors you decide to do business with. Throughout your life this has the potential to save you thousands if not, tens of thousands of dollars if applied correctly.
Nothing stated in this article is a recommendation from Forehand Financial to buy or sell a particular security or asset class. You should wisely consider your tolerance for risk, time horizon, and financial goals before making an investment. With investing, you run the risk of losing money, always read an investment prospectus and make an informed decision before allocating capital to a particular investment.