Credit Scores Is A Poor Man’s Game
None of it matters if you’ve got real wealth.
The concept of credit scores has taken over the media over the last decade. The more we hear about it, the more we feel obligated to join in and raise our own scores.
There’s a lot of advice on how to raise it, but few people go into the what for aspects of credit scores.
Over the years, I come to realize that a credit score is the ultimate poor man’s game that’s aimed at making you feel rich — but not make you rich.
How credit scores work
A credit score is a historical file that tracks how good you are at managing your debt. Lenders use this score to determine how likely you are at paying your debt back on the agreed timeframe. How you manage your money behind the scenes is none of their concern.
What they care about is that if they give you money, can you pay them back?
Contracts can end up costly and cut into their profits if they have to chase you down for the cash. Having a low risk, drama-free customer can help maximize their profits with minimum processing overheads.
Why? Because lending money is a business and businesses often exist to generate a profit. There’s nothing evil about it. It’s just the way the world works.
A credit score is part of the equation they use to calculate risk. The lower your credit score, the riskier it is for them to lend money, the higher the premiums and interest rates will be.
It’s sort of like your grades being an entry requirement into higher education. You need to show a certain grade-point average in a particular area to get into a certain course. A good credit score is often a prerequisite to getting your credit card and loans approved.
How focusing on credit score is flawed against wealth-building logic
Wealth rests on the sum of your assets and liabilities. Net positive wealth is when the value of your assets outweighs your liabilities.
Liabilities are anything that you owe — your student loan, your credit card debts, your loans, your layby payments, your taxes due, and anything else you need to pay up.
Your asset is what you fully own. They are the things inside your house — your computer, your laptop, your tv, your car, your fridge, and everything else that you own. They are also the money you have in the bank, the money you’ve got invested in places, and any money generating thing like a business.
An asset with debt against it is not an asset. This is a common mistake that people make when trying to figure out what their net worth value is.
Another thing with assets is that value often goes down over time, especially for consumer goods. This means that unless it’s over a few hundred years old, not mass-produced, and in mint condition, the value of you paid for is not its actual value.
Fixed assets are things that take time to sell. These are things like land, property, and large specialized equipment. Fixed assets are often high in value and are often tangible — you can touch it, you can see it — it’s as real as can be. Fixed assets are limited in stock and often go up. However, its price can be over-inflated and when deflation hits, the losses can be big — but that’s a different story.
Most of us don’t have fixed assets. In part, it’s because fixed assets are expensive.
What many of us have are liquid assets. This is the cash in your accounts, your invested money that’s not locked, and what you can sell quickly from around the house if things fall apart.
When you take on debt, you reduce your overall net wealth. You may think the sum of the asset bought with the debt is equal — except it’s not.
The moment you buy that car, tv, $100 t-shirt, furniture, or whatever other physical good you’ve decided on, it loses its value instantly. The moment it becomes yours, your net wealth gets reduced by the difference of its new value and the amount you borrowed to get it.
Sure, your credit score might go up a little if you pay it off — but you end up a little poorer.
There’s more to wealth than just owning stocks and things
The point of taking on debt is that it’s supposed to propel us ahead in some manner. For example, taking on debt to get a qualification only makes sense if the degree or certification lifts your earning potential.
Sometimes, we miss-calculate (or in the cases of many college students, don’t calculate at all) the difference between the cost of debt and the actual earning potential lift, leaving us worse off in the long run than not pursuing higher education at all.
While many articles often talk about investing your money, they disregard the power of being debt-free.
When you are at zero debt, your true net worth isn’t gobbled away by liabilities you owe. What you see is exactly what you have. This leaves you with the financial capacity to invest and increase your wealth without it being a zero-sum game.
The point of being wealthy is to enjoy the pleasures of life without having to worry about its cost. Emergencies become inconveniences rather than a cascading financial domino effect. Early retirement is possible and you have the choice to pursue other activities without endangering your current lifestyle.
It’s faster and much easier to become a millionaire when you have got no debt nibbling at your income. What many people don’t realize is that debt often inflates faster than the rate of inflation itself. Interest rates often sit above growth rates for this very reason.
What many models and investment calculations do is predict growth against a straight line. However, in reality, this line fluctuates in tune with what the government is doing, how the global economy is doing, and any other breakthroughs, natural disasters, events, trend boosts, and whatever else is happening.
The models and calculations don’t take these into consideration. We need to figure this out ourselves and decide on which way the curve will swing and when.
Debt, however, is permanent and plotted out on a straight line based on the contract you signed. There is no deviation. If your investment goes bust, your debt remains the same.
When you have a high debt ratio, your financial margin of safety is also very low. This creates more risk overall and if you fail or miss a debt repayment, the score you worked so hard at raising through debt incurring techniques will turn against you.
When is your credit score useful
Credit scores aren’t evil. Rather, they’re just a measure of trustworthiness for us common folk.
Sometimes, landlords and utility companies use them to figure out if you can pay them on time. Most of the time, it’s used for a major fixed asset purchase. Mortgage leaders often look at your credit score — but it’s not the only factor they look at.
Even if your credit score is mediocre because you’ve never taken out credit, showing a history of saving and building wealth over time has the same impact. There’s just more paperwork to hand in as proof.
Your credit score exists to help mortgage lenders assess risk, and the higher your credit score, the lower the risk you’re supposed to be. When you have wealth and want to take out a mortgage, what’s happening is that you’re turning what you own into a different kind of asset — from liquid to fixed.
When you have debt, you just owe other people your assets.
It’s a different kind of game you’re playing when you focus on building wealth rather than your credit score.
The wealthy and free don’t talk about their credit scores. No. That’s the stuff for us middle and lower class folks to worry about.
Because they don’t need financial help to get what they want. They’ve got the money to just buy it.
And wouldn’t it be nice to just walk into a store and buy something with cash? Wouldn’t it be nice to skip all the paperwork, the application processes, the phone calls, the waiting, and whatever else that’s needed for someone to give you money?
Being wealthy is more than just being able to afford designer brands and highly-priced items. It’s about living within your purchasing power. If you want to increase your purchasing power, increase your wealth.
How do you exactly go about increasing your wealth?
The quick answer is to make more money. The alternate answer is the grow your money. The long answers to these things require a stand-alone piece to do it justice.
Whatever the case, when you’ve reached a particular level of wealth with at least one fixed asset completely paid off, credit scores no longer matter.
So work towards that instead — work towards being wealthy enough that you don’t have to worry about credit scores because you don’t need it. You’ll be happier for it in the long run. Personally, I’m halfway there on my journey and I’ve never felt closer to financial freedom in my life.