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4 Reasons Credit Score Tips Can Be Useless

This article is more than 8 years old.

We are obsessed with credit scores in America. I regularly host financial literacy seminars. During those seminars, participants have the ability to ask questions. And rather than asking about how to get out of debt, plan for retirement or save money, the majority of questions inevitably focus on credit scoring. We have somehow convinced ourselves that having a good credit score means that we have achieved financial success. Credit scores have even become a factor in dating, with some dating websites helping people filter potential partners based upon their FICO score range.

Like so many other algorithms, credit scoring algorithms play an important role in our lives. Having a good credit score means your life has the potential to cost less. The interest rate on your mortgage can be lower. Your auto insurance premium can be reduced. However, whenever we focus too much on one metric, like a credit score, we inevitably lose sight of the bigger picture.

During my career, I often try to convince people to worry less about their score, and more about their financial well being. Here are four reasons that chasing the best credit score can often be the wrong decision.

1. A Good Credit Score Is Only Worthwhile If You Use It

The purpose of a good credit score is to help you save money. However, I often meet people who are afraid to use their credit scores to save money. Instead of applying to refinance their mortgage or their student loan, they would rather protect their scores. Take the example of student loan debt. With interest rates so low, now can be a great time to reduce the cost of your debt. SoFi, a leader in student loan refinancing, has saved its average customer $14,000. And a single credit inquiry, according to FICO, will take fewer than five points off someone's score. Even better, multiple applications for student loans, mortgages and auto loans in a thirty day period only count as one inquiry.

So, would you be willing to spend $14,000 to protect five points on your credit score? That seems like a steep price for a few theoretical points.

2.  There Are A Lot Of Credit Scores Out There

Although we regularly talk about our "credit score," the truth is that there are countless scores in use. And chances are high that whatever credit score you are looking at is not the score that will be used by your lender. FICO is the leader in credit scoring. But there are different FICO scores for different products. And, within each product, there are different versions. Another popular credit score is the VantageScore, which is being used by free credit score sites like CreditKarma, CreditSesame and Quizzle. VantageScore is similar to FICO, but it is not exactly the same.

And most banks don't use a generic score in isolation. Instead, teams of data and risk analysts create custom credit scores. The version of FICO used by your bank may be only one factor in a custom scorecard. When I ran risk management and scoring teams, my job was to prove that we could build a better score than the generic score. Every bank and lender has their own risk manager, looking to build a score that is just a bit better than any off-the-shelf scorecard. So, if you are obsessing over a few points on your free credit score from CreditKarma, you are probably wasting your time.

3. Other Financial Indicators Are Much More Important

People with an 800 FICO Version 8 credit score can still be rejected by their bank. In addition to looking at credit scores, banks will review your income and debt burden. Credit scores do a very good job of indicating whether or not you have made payments on time in the past. People with the best credit scores tend to have an on-time payment history and haven't maxed out their credit cards.

However, if you have $20,000 of credit card debt, an 800 credit score and annual income of $25,000 you will most likely be rejected by your bank. Just because you have found a way to make your payments on time every month doesn't mean that you are financially healthy. Your goals should be eliminating your credit card debt, saving for retirement and paying off your mortgage. If you do those things, a good credit score will likely follow.

4. Most Credit Scoring Experts Don't Know All Of The Details

Credit scoring algorithms are complex, and the details are only shared with employees of the company creating the score. Credit scoring experts, myself included, can only use our experience and publicly available information to help guide the public. You should focus on the general direction of the advice, and not get hung up on some of the details.

Here is a great example. According to FICO, and in my experience building custom scorecards for banks, utilization is an important indicator of risk. If someone is maxing out all of their credit cards, they demonstrate a much higher credit risk. The lower the utilization, the better. But what is the right level?

CreditKarma has developed a tool to help people view their VantageScore. CreditKarma's guide, based upon analysis of their users, shows that 0-9% is excellent, and 10-29% is good. I have built many credit score over my career, and having a utilization below 20% helped people achieve very good scores.

As humans, our lives are easier if we can get a simple rule. I feel comfortable advising people to keep their balances below 20% of available credit. But the bigger, more important test is to make sure you are never charging more than you can afford to pay, in full, every month. Given most credit limits are multiples of your monthly income, that will likely keep your utilization well below 20%.

But if your utilization goes to 21% in a month, that does not mean your score will crash. The advice is directional. It is obvious that utilization of 80% would have a huge impact on your score. So, focus on the directional advice and do not worry about small differences.

What Should I Do?

Your goal should be financial health. If you stay focused on financial health, a good credit score will follow. Eliminate credit card debt. Use a credit card as a convenient form of payment. But never charge more than you can afford to pay off in the month. In general, keep your balance low. The lower the better. And always pay on time.

You can then spend time working on your budget and retirement plan. Spending time thinking about your future, rather than 20 points on a credit score, is a much better investment of your time.