Sunday, June 17, 2012

Why Your Credit Score Isn't Everything

Even if you had a great credit score (and 720 ain't great), that doesn't mean you can borrow all you want - or that you should borrow all you want.

I have a great credit score - well over 800.  I don't check it often, in fact, not in a few years.  But I know from experience that when you are my age and have several paid-off mortgages under your belt, no delinquent or late debts for a decade or more, and no debt whatsoever, well, your credit score is stellar.

And there are some folks out there who would be jealous of this.  Folks with credit scores in the 600's, who think, "Gee, if only I had a 770 or higher....."

Well, hold on there, cowboy, because Credit Score ain't the whole deal - not even a big part of it.

Your credit score really tells only part of the story - whether you are conscientious about paying back debts, and paying them back in a timely manner.   There is a whole other part that banks and lenders consider before loaning money.

Debt-to-equity ratio and debt-service-to-income ratio are two big factors.  If you have $500,000 in assets and $1,000,000 in debts, you are basically insolvent, even if you are making your payments on time.   And not surprisingly, banks have limits on how much they will lend to you, regardless of how prompt you are on servicing your current debts.

More importantly, they are not going to lend you more money than you can pay back, based on your current income - particularly today.   Mortgage agencies consider a borrower who spends more than 1/3 of their income on mortgage debt servicing to be "mortgage stressed".   Simply put, if you are spending that much on a mortgage, you are likely spending the same amount on taxes, leaving only 1/3 for living expenses.  

Lenders will not keep loaning you money, even if you are current on all your bills and have a 830 credit score, if by loaning you that money, you will end up sucking air at the end of the month.

Well, some lenders will, but the good ones won't - and will explain to you why.  Listen to them, carefully.  They are giving you good advice when they say "No" to a loan request.

So many consumers think of banks as "mean" when they refuse to lend money.  But an intelligent bank is not going to lend money to a consumer if they think the consumer won't pay it back.   Crooked banks and lending institutions will still lend you the money, but they figure your financial ruin in as part of the deal, and calculate how much interest they can get out of you before you go bust.  Yes, it is true, today you can make more money ruining someone than in establishing a mutually beneficial business relationship.

And that is why it behooves you to think long and hard before borrowing money.  Borrowing money is not a treat or a privilege - it is an onerous responsibility, and money that has to be paid back, over time, with interest.

Thus, even with a stellar credit score, no bank is going to lend me $300,000 to go buy a Mercedes Maybach Limousine, even though I could afford to buy one and pay cash.   The bank would realize that my income would not support such a ludicrous purchase.   And the bank would be right - it would be a silly thing to buy.  It would be a bonehead stupid financial move.

That doesn't stop a lot of people from doing similar things - buying expensive boats, vacation homes, cars, bus motorhomes, or just racking up credit card debt - which they think they can afford, but really can't.

And such folks obsess over their credit score - as if a high score means you qualify for another piece of internal-combustion-powered eye-candy to buy.

But just because you CAN do something, doesn't mean it is a swell idea.

You see, in order to have that stellar credit score, you can't be up to your eyeballs in debt.   It is like trying to save up a million dollars.  It can be done, but once you start spending it, well, you no longer have a million dollars.  You can't do both.

It takes a lot of self-control and self-denial to do these things.  And both are characteristics lacking in modern Americans.   Most Americans can't wait for their "next car" or their "new cell phone" - as if life were a series of financial transactions, upgrades, and trade-ins, on their way to the ultimate upgrade.

Obsessing about your credit score is short-sighted.  But all the financial gurus tout it, as if this number was the only and only indicia of your financial health.  But it is not.  Your net worth and debt-to-equity ratio are far more important.   You can't borrow your way to wealth, particularly with consumer loans.

1 comment:

  1. Here's a good one for you: Since I have paid off all my debts and have no mortgage, my credit score has gone DOWN from over 800!

    I have NEVER been late on a payment, NEVER been in default, NEVER been in bankruptcy, NEVER had a judgment against me - nothing!

    And my net worth is over a million bucks.

    But they bankers don't like it when you stop playing their little game.

    When you stop BORROWING money, ironically, it lowers your credit score!

    Pretty freaking bizarre, ain't it?

    Thankfully, since I am debt-free, I don't really care about my credit score much anymore.....

    ReplyDelete

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