Monday, August 16, 2010

Gaming Your Credit Score

Trying to tailor your behavior around your credit score is like trying to structure your life around the tax code. Both are bad ideas.

The AARP magazine has some horrible financial advice - what of it isn't merely banal. In the "my 2 cents" column, one columnist advises a client about how to cancel a credit card without affecting their almighty credit score. She notes that it is "OK" to have a large number of credit cards, provided they are all paid on time, and that this actually will increase your credit score.

All of that may be true, but it is not good advice. Why?

Credit Scores are designed to give financial institutions an idea of your creditworthiness. If you pay your bills on time, and your debt is low, chances are, you have an excellent credit score. In short, you have nothing to worry about in terms of getting credit, because, as the old saw has it, in order to borrow money, you first have to show you don't need it.

And if you don't need to borrow money, why borrow? Even 0% interest rates are no "bargain" on cars with inflated prices. And old people reading AARP should be (should be) in a position where they have little or no debt.

Now granted, in any system, there is a means of gaming the system. Our evaluation system at the Patent Office was case in point. You could do a good job and get a fair score. Or you could game the system and get a better score, but perhaps not do as good a job. The gamers may have had short-term gains, but in the long run, they often were not as happy or successful than those just doing their jobs well.

The same is true of the credit scoring system. Trying to "game" the system by having multiple open lines of credit and taking other actions with an eye toward boosting your score may work - or it may go horribly wrong. Many of the things the credit score people score you positivity on, are things that can personally work against you.

For example, having multiple open lines of credit might increase your score. But on the other hand, if you run these up, you may find yourself unable to pay them off. So goodbye good credit score, and hello bankruptcy.

And again, while 70% of Americans claim to pay off their balance every month, 70% of Americans also carry a balance every month. Clearly, at least 40% of us are lying.

In addition, the more credit cards and other debt instruments you have, the greater the likelihood you will miss a payment, miss a statement, or otherwise loose track of your finances. Simplifying your finances is a much better idea than having a fat wallet full of plastic.

Rather than try to "game the system", I think a safer approach is to have very few credit cards. Pick ones with reasonable credit limits and LOW INTEREST RATES. That way, if you do get into trouble (unexpected emergency) you can pay off the balance in a reasonable fashion.

Many credit card companies today offer rates lower than 8% - sometimes far lower. Having a 22% "miles" card in your wallet is like having a loaded handgun. If you ever use it for an emergency, good luck paying it off. And those frequent flyer miles are impossible to use, anyway.

Gaming your credit score is, in a way, like structuring your life around the tax code. Yes, the IRS gives you a credit for buying an electric car. This does not mean you need an electric car, however. If you make all your decisions based on "well, there's a deduction or tax credit" then you'll own two homes, a farm, several "alternative fuel" vehicles, and a windmill. If you want these things, great. But wanting them because there is a tax credit or deduction is silly.

Think about it. Who would go out and have children, just for the tax deduction? It makes no sense, financially.

And by the time you retire, your credit score should be excellent and you shouldn't need it (the two go hand in hand, oftentimes). You should own your own home by then, and you should own your own car as well. Seniors drive very little, and there is little point in buying new cars all the time and financing them, if you are driving only a few thousand miles a year.

And if your credit score is poor, chances are, all the gaming in the world isn't going to improve it much. The big ticket items - unpaid debts, bankruptcy, foreclosure, delinquencies, and the like will tank your score no matter what. You can't fix that by the few extra points you get for having an old Sears card or for having an open line of credit.

And bear in mind that not all credit reporting agencies score the same way. And not everyone goes by score alone. Open lines of credit can damage your credit, as it limits how much you can borrow. I've been declined for a credit card, not because of my credit score (which is excellent) but because I already had other open lines of credit.

Similarly, bankers look at your open lines of credit with a dim view. They know that regardless of some computer-generated "scoring" system, that a consumer can go heavily into consumer debt and never get out. Do you really want to write a mortgage to someone with $100,000 in open credit lines? They could go out tomorrow and run it all up, and you'll have to foreclose on their property.

The only people that go by the credit scoring system are often the people you are least likely to borrow money from - consumer lending agencies. These are the types of people who charge the highest interest rates on loans. Yea, the guy pushing the loan through at HFC might only care about your score. But chances are, a mortgage lender is going to look at more than just a number. And opening lines of credit to improve your score will surely backfire in that scenario.

So forget gaming the system. A better approach is to use good old fashioned common-sense. Borrow less. If you need to borrow, get the lowest interest rates possible. Work toward being entirely debt-free as a lifetime goal. Learn to live on less "stuff". You don't really need a jet ski, trust me!

And stop obsessing about your credit score!