Do you have a credit score of 740 or more? Well then you must be a financial success! Or maybe not….
What does that credit score really mean?
According to MyFICO.com, a credit score is made up of five categories:
- Payment history – do you pay your bills on time?
- Amounts owed – the lower the balance the better (but not stagnant at zero)
- Length of credit history – the longer the better
- New credit – some is okay, too much is a red flag
- Types of credit used – it’s best if you have credit cards and installment loans (car loan, student loans, etc.) and manage them responsibly
So let’s step back for one second here. After reviewing these five categories, what actions actually build up a high credit score?
- You continually use debt, but you pay your bills on time
- You have student loans, car loans, mortgage loans, and of course…credit card balances
Does this sound like the actions of the wealthy? When you hear Warren Buffett speak, does he ever say, “To get ahead in life, make sure you take out loans for school, your cars, and your house!“? Ummm…maybe in the bizarro world…
Credit Score – The Illogical Measure
Bill is a project manager at a local advertising agency. He’s 40 years old, has $20,000 left on his student loans, has a $25,000 car loan, and a $300,000 home loan. His net worth is just $10,000.
Lisa is a project manager at the same agency as Bill. She’s 42 years old, has no student loan debt, drives a paid-in-full Lexus, owes just $50,000 on her home, and she’s never had a credit card in her entire life. Her net worth is $500,000.
If you had to loan someone money, who would you pick??
My pick would definitely be Lisa. After all, she actually has money to pay me back with!
Guess who the banks would take? Bill! For the simple reason that he’s never missed a payment. Sure, he basically has no money, but he’s proven his ability consistently pay on multiple debts. Since Lisa has not borrowed much money (and therefore has little credit history), FICO would keep her score low, making it more difficult for her to get approved for future loans.
So basically, if you want to have a great credit score, you need to keep borrowing money. Does this make any sense at all??
The credit score is so illogical to me that I often contemplate having a zero credit score. In other words, since I have no debt, I could just cancel my credit cards, have no recent credit history, and let my score drop to zero. This is the point where many of you get tremors and can’t help but think I’m nuts, but maybe there are some benefits to having a zero credit score!
Let’s dive into the pros and cons…
Pros of a Zero Credit Score
Having a zero credit score won’t win you any extra prizes in life, so this list is basically the pros of having absolutely no debt source – or no credit cards if you will.
1) I get rid of the temptation of debt – If your New Year’s resolution was to stop drinking alcohol, then you probably shouldn’t go to the bar because of the free peanuts. Eventually, you’re going to order a drink.
It’s the same way with debt. If you’re completely out of debt and have no intention of going back in, then why would you continue to use credit cards? Eventually, you’re going to charge up those credit cards again.
2) Become wealthy with no interest payments and high cash flow – When you get through the debt snowball and get rid of all your payments, you suddenly have a massive positive cash flow. Stop borrowing money and that cash with grow and grow, and then compound on itself!
3) Avoid the meaningless promotions – Remember the free peanuts I mentioned above? The free peanuts of the credit card world are “reward points”. One time bonuses and 1% cash back on purchases. It seems pretty smart to use credit cards to earn all the “free money”.
In reality though, we get very little from our spending. You could rack up $30,000 of expenses in one year and what does that earn you? $300. Bravo. You’re a super genius. Not.
4) I’ll decrease my spending – When you swipe a credit card, you don’t see the pain of the purchase. AND you don’t experience it until over a month later when the bill comes due. The emotion of spending never matches up to the pain of actually paying for it.
When you use cash or a debit card, you see your money stash decrease immediately. It’s enough to think twice about what you’re actually buying.
Using a credit card instead of cash will cause you to spend 12-18% more money on your purchases.
5) Reduced stress – What would it feel like if you had absolutely no payments? You owe nothing to anyone. You’re free. Breathe in…and breathe out. You’re free. Feels pretty good right? Get rid of all your debts and your stress level will go down dramatically.
Cons of a Zero Credit Score
Since the world believes that your credit score defines you, having a zero credit score can pose some challenges in your life.
1) Difficult to buy a house – If you don’t have a credit score, getting a mortgage from a bank can be nearly impossible. You basically have two alternatives: 1) You pay cash for your house, or 2) you find a company that can manually underwrite your mortgage (Churchill Mortgage is the only one that I know of).
Cash isn’t an option for most and finding a company that will underwrite a mortgage can be tough. Once you find one, you need to prove (with four different regular payments) that you have made on-time payments over the past 12 months.
2) Higher insurance costs – Car insurance, life insurance, and home insurance companies base your rate partially on your credit score. If your credit is bad (or if it’s zero), you’ll have to pay thousands more in insurance each year.
3) Difficult to rent vehicles – According to a few reports I’ve heard recently, it can be incredibly difficult to rent a car if you don’t have a credit card AND have no credit score.
These are the two go-to’s for a rental car company and if you don’t have them, they really have no guarantee that you’ll pay them for potential damages. If you don’t mind jumping through hoops, you can probably win over a rental, but it’s certainly not easy.
4) Forced to pay deposits – No credit score? Be prepared to pay deposits to your next cell phone provider or the new utilities company after your future move. If you have a ton of money, then it’s really not a big deal, but it can be a nuisance to leave a few hundred bucks with various companies throughout the year.
5) Might not be selected for a job – This one is a bit far fetched, but it’s probably happened a few times for sure. If two job candidates are equally talented and intelligent, but one has a 790 credit score and the other has a zero credit score, the hiring manager would likely choose the candidate with the high credit score because she has proven her “character” with many on-time payments to her debtors. Just saying that makes me throw up in my mouth a little, but it’s simply the reality of the world we live in.
What Should I Do?
I’ve decided that this is pretty much a lose-lose situation.
- If I keep my credit cards and my credit score, I’ll probably spend more money.
- If I ditch my credit cards for good, then I’ll probably spend less frivolously, but I’ll have to pay additional deposits, and companies are going to charge me more since they don’t trust my non-existent credit score.
So should you have a zero credit score? Meh, I really don’t see the point.
Here’s what I plan to do. I’ll commit to using my credit card only for gas and for crazy large purchases that I’m going to make anyway (for a few bucks in rewards because like I said, I’m going to spend that money anyway). For everything else, I’ll use cash and my debit card.
What about you? Have you ever thought about having a zero credit score?