What is a Credit Score?
Updated: Sep 30, 2019
Everywhere you go, people say you need to build your credit score. You need to have a high or good credit score. You can't buy things if you don't have good credit. The question becomes, why do you need a good credit score?
Spoiler alert, you don’t need a credit score at all and we at A to Z Financial Freedom can guide YOU on how to achieve that goal!
What is a Credit Score?
First, let’s go over what a credit score is. A credit score is what you need if you want to take out pretty much any type of loan without doing some extra verification work. Basically, it makes life easier to get loans.
A loan is when you borrow money and pay for borrowing that money with interest. So, if you borrow $1000, you will have to pay more than $1000 back, even if you only borrow the money for a few hours.
The calculations used for a credit score are kept fairly secret by the three main reporting agencies (Experian, TransUnion, Equifax). But we do know the basics that get factored in.
Age of credit history (how long have you have you been borrowing money)
Credit Card Utilization (balance vs limits on your credit accounts)
Payment history (have you paid on time, early, or late)
Hard Inquiries (how many times you apply for loans)
Number of Accounts
Other Derogatory marks
Each one has a certain weight to it that no one really knows but the insiders.
Do I need a credit score?
The question you have to ask yourself is quite simple. Do you want to borrow money? If you do, then you will most likely not be a millionaire. If you don't, then you DO NOT need a credit score as you won't be taking out loans.
Usually people give some pushback for this. How am I going to buy a car or buy a house?
These answers are fairly simple, especially for a car.
To buy a car without a credit score all you have to do is pay cash for it! That IS it. No credit check required if you are paying cash. Doesn’t matter if you have good, bad, or zero credit.
Now the pushback here is how can you pay cash for car? They are too expensive to do that! Well, if you can’t afford to save and pay cash for your cars, then you can’t afford to buy those cars. Things with motors in them shouldn’t be worth more than 50% of your annual income. If you make $100,000, your cars shouldn’t be worth more than $50,000. Make $70,000, no more than $35,000 in cars. Why? Because cars go down in value. Usually after 2 years, they are about 50% of their value. So, $35,000 in a new vehicle will only be worth about $17,000 two years later. Can you afford to lose $17,000 in two years?
So, buy a cheaper car that you can afford to pay cash for and then continue saving to upgrade to a nicer vehicle in the future, but always keep under the 50% of your annual income mark.
Guess what another nice thing about paying cash for cars ensures, you pay 0% interest every single time. You don’t have to try and qualify for those deals, you pay yourself 0% interest. You have actually made some interest if you saved your money in a bank or money market account. Not much, but better than paying it!
You also maximize all cash rebates as most rebates happen if you DO NOT take the 0% offer. Finally, if they are asking $35,000 for the vehicle, and you have $32,000 in cash, sitting on the table, and are willing to walk away, they will usually take it. If not, you walk away. You will probably be receiving a phone call in a few minutes from them. Why? Because quite a few dealerships have loans on the vehicles they offer and they need to move them.
Here is an article on Car Depreciation by carfax
Here is one by Kelly Blue Book Car Depreciation
Here is more information on how to buy and maintain a car Dave Ramsey's Car Buying Guide
For a house, you CAN pay cash for it, but that isn’t always easy. This has the same principals of buying a car. If you have cash in hand for your house, you can close quicker and that can mean you can offer less. It would be ultimately the best option, but you can also still get a mortgage with a 0-credit score.
How do you do this? Find a mortgage broker that will do manual underwriting. This is where you need to have a nice size down payment ready, work history showing that you can make the payment, and rental history showing that you paid on time or early from your previous landlord. There are some additional items that you can talk to a mortgage broker about to qualify for manual underwriting. It is the process that mortgage companies used to do prior to the invention of the credit score.
How do you get a ZERO credit score?
That part is the easiest of them all. Have ZERO debt. This means, no student loans, no credit cards, no home mortgage, no car loans, no late bills on your history, etc. You will need to do this for about 6 months and your score will fall to zero. It might take longer than that, but that is usually about the amount of time it takes.
Who made this credit score thing?
Ever walk into a bank? Do they have nice furniture? Desks? Everything is nicer than your house?
Have you ever gone to downtown Phoenix and looked at the names on most of the tall buildings? What about the sports stadiums?
Seeing a pattern? The banks can afford these things because of the interest we pay them each month. They are charging you 6% interest on the money they loan you. But the money YOU loan THEM only earns .01% if you are lucky!
Banks made the credit score to make their lives easier. There is nothing special about it. They just didn’t want to do all of the legwork to verify that you can actually pay back the loan that they are giving you. They realized this legwork costs them more time and money. So, to make their lives easier they made this credit score which decreased the amount of legwork, increased the amount of loans they could make, and ultimately increases the amount of interest they collect.
So, to recap;
You DO NOT need a credit score.
A credit score is something banks made up to maximize the amount of loans they can make in the least amount of time, which ultimately maximizes the amount of interest they collect.
Everything can ultimately be paid for with cash. This will also save you money in the long run, including on cars and houses.
If you need help on saving for a car or house, schedule your free consultation today and we can show you how to do this!
Until next time,