Debt Free

While being debt free is a laudable goal, you can take anything too far. It can be important to have some debt at times, if for no other reason than to increase your credit score. How can this increase your credit score? The debt, in and of itself, won’t increase your credit score. The problem for some people, however, is their relative lack of credit history. They’ve never had credit cards or any sort of bank or finance company loan, either.  When it comes time to buy a new car, or get a mortgage, the lack of credit history can leave these folks either out in the cold, or paying much higher interest rates than they otherwise would. 

Your credit score, or FICO score, is one of the prime determinants in the rate you’ll pay when you get any type of financing. Roughly 35% of your FICO score is derived from your payment history, and another 15% from the length of your credit history. Obviously, it’s important to have some credit in order to have a payment history and a length of credit history. The earlier you get credit, the longer your history, so it’s important to get at least some credit, even if you get a credit card, use it a few times a year, and pay off the entire balance in a single billing cycle. This, incidentally, is what you should do. Only use your credit cards for purchases you’d have made anyway, and, now listen up, pay them off right away.

To illustrate how this strategy can help your credit, the difference in the interest rate (as of Nov. 3, 2006) between a 30 year fixed mortgage with a FICO score in the 620 – 659 range, and the 580 – 619 range, is 7.202% for the higher score, and 8.26% for the lower range. Needless to say, this is a substantial difference, and illustrates how a seemingly minor increase in your score could save you large sums of money. It shows why you should know your FICO score before you seek financing. If you were ignorant of your score, you could be looking for a mortgage, never knowing a 10 point increase in your score could lower your mortgage interest rate over a percentage point! If your FICO was above 659, you’d do better still, at 6.392%. Those rates are reflected in your house payment to the tune of $1,880/ month at the higher rate, down to $1,562/ month at the lower rate, for a $250,000 mortgage.

Another fallacy that can affect your credit score concerns your income level. While your income can definitely affect your chances of getting a particular loan or mortgage, it has no effect on your FICO score. Too many people are under the impression that a healthy income will insulate them from the effects of a negative credit history. While that may be true to the extent that you’re less likely to need credit if you have a substantial income, it won’t do anything to raise your FICO score. Fair Isaac, the fine folks that bring you the FICO, report that a survey performed by the Opinion Research Corporation in Feburary show that 45% of respondents falsely believed that getting a higher paying job would raise their credit score.

Another interesting bit of information gleaned from the survey reflected American’s misunderstanding of their credit score in general. Only half of those surveyed correctly responded that your credit score was a measure of risk likely to be faced by your prospective creditor. The remainder mere under the mistaken opinion that your credit score was a measure of credit availability, knowledge, or debt levels.

The important thing is, in preparation for getting a mortgage or car loan, get a bit of credit first. Don’t take it too far. You don’t need a honeymoon to the Cook Islands, a bitchin’ new 50” plasma, or some of those bling-bling dub-dubs for your ’99 Accord. Be a bit sensible, get one or two cards that you use rarely, and pay off regularly. In a year or two, when you’re ready to get into your first home, or get a car loan for your first family car, you’ll be rewarded with much more favorable credit terms. In some cases, the credit history can allow you to even get the mortgage or car loan at all.

One Other Note: Rosie O’Donnell continues to set a new standard for complete ignorance of world events, and the behavior of certain segments of the world’s population. This is evidenced by her remarks on the TV show “The View” last week, when she indicated we should not be concerned by the terrorists because they are mothers and fathers. Well Rosie, you should really take a few steps back and reevaluate. Anyone with a modicum of common sense would have realized by now that it’s just as easy for those who happen to have children to strap on a nail and C4 laden vest for a trip to the market. Rosie, maybe you should actually venture out from behind the gates of your walled community, and speak to some of those in the world who are, and have been, affected by those loving mothers and fathers.