Updated: Jun 27
Credit scores have become more or less an obsession for many. This obsession is not surprising given the level of importance that has been attached to having a good credit score. Having a good credit score not only influences your borrowing decisions, it also affects your creditworthiness and how willing lenders will be to release funds to you. But does a good credit score mean that all your financial problems are solved? Unfortunately, that is not the case. A good credit score does not in any way guarantee that you won’t become insolvent. In fact, focusing too much on attaining a good credit score can actually put you at risk financially.
Why focusing on credit score can be dangerous
Being obsessed over your credit score can cause a lot of harm in ways you might not expect. So, what are some of the dangers associated with chasing a good credit score at all costs?
1. The effect on your payment history
One of the factors that determine your credit score is your payment history recorded over time. Your payment history accounts for thirty percent of your credit score. That is quite a large proportion.
If you meet your payment deadlines, your credit score will be positively affected. However, a lot of other indices come into play here. For example, you might not get the full benefits of promptly paying your bills because not every payment is tracked. So paying your balance in full may not have the effect you’re anticipating if you don’t know the payments that count.
What this means is that a person who is behind on their rent, has a running car loan but pays the minimum on credit card debts can have a higher credit score than one who has just one credit card. Lenders would most likely lend to the former than the latter.
2. Your credit utilization rate
Credit utilization is an important element used in determining a credit score. It is the ratio of the credit extension that you can use. This is what makes it possible for a person with lots of credit cards and running loans to have a better credit score than a person with just one credit card.
The credit score system can only assess your creditworthiness and risk if you utilize credit. What this means is that to have a better credit score, you will of necessity need to use credit. By increasing your credit limit, you can lower your credit utilization and improve your credit score.
It is important to note that your income level does not factor in the determination of your credit score. A person who earns $200,000 annually with four credit cards, has a limit of $30,000 on each and an $8,000 outstanding can have a great score. This score can be better than that of someone with one credit card and $1,000 outstanding.
Losing the chase
Credit score was designed with the banks and lenders in mind, so your efforts to game the system may not work to your advantage. While you may succeed in increasing your credit score by tailoring your borrowing in such a way that the credit rating favors you, at the same time you may be hurting your finances.
Borrowers are expected to hold a 30% utilization rate to improve their credit score. This also means that you will be paying substantial interest and may run into a debt cycle that you cannot recover from. Increasing your credit limit can work wonders on your score. However, it also means you will have more debt on your hands.
Fortunately, there are other ways to make the purchases instead of relying on credit. To increase your personal equity, you can start saving and investing more rather than focusing on building a credit score to make purchases, which generally decreases your net worth. Existing solutions such as low-interest savings accounts and fee-laden financial services are not apt for a post-pandemic world. With Qinta, you can earn up to 10% on your savings and reach your financial goals faster. Sign up for early access here.
Focusing on your credit score may not be the best way to approach your finances. You can still succeed in having a good credit score but be on the verge of going bankrupt.