Nearly every personal finance guru in America will tell you that it's important to build and maintain a high FICO score -- and that good credit is a sign of financial prudence and responsibility. Lenders will reward you for that responsibility with a lower interest rate loan.
The worship of the almighty FICO score has even been picked up by AOL's own welcome screen -- AOL.com recently ran the headline How Woman Got a 783 Credit Score. According to the article, "It's the kind of credit score that belongs to a person who spends her money and swipes her credit cards wisely."
That's really only partly true. In reality, a good credit score comes from using credit in a reasonably responsibly way: i.e. not missing payments and maintaining a reasonably low debt-to-credit-limit ratio. But a high credit score also comes from using credit a lot, and having a lot of different kinds of credit. The piece goes on to say that "Excluding mortgage, household expenses, a low school loan payment and two bank credit cards, her extra funds mostly go to savings with a little for herself and Quinn's needs. Not that (Stacey) MacGlashan is a big saver, either. (That's her admission.)"
Here's the problem with buying stuff with credit cards to build up your credit: You'll spend a lot more money than you would if you paid with cash. And what about car loans? As Dave Ramsey has shown on his website, paying cash for cars could ultimately lead to a retirement nest egg of more than $4 million.
The truth is that the best way to build a great credit score is not necessarily a great way to build wealth. There are plenty of people who are completely unprepared for retirement, living paycheck to paycheck with negative net worths who have fantastic credit scores.
A high credit score means that you tend to manage money in a way that makes you a good person to lend money to.That's very different from managing money in a way that will help you build wealth.
Ah, you say, but wait! "If you don't have a high FICO score, you won't be able to buy a house or, if you can, you'll have to pay a higher interest rate."
Actually, that isn't necessarily true. A high FICO score can certainly make getting a mortgage easier -- but the trade-off isn't worth it if car loans and credit card payments limit your ability to save. And with FHA loans available to first-time buyers, you only need a credit score in the 600 range -- which you can acquire pretty easily with very occasional credit use. And if you don't have enough of a credit history, the FHA can look at other factors (utility bills, etc.), as can some credit unions.
The moral of the story is this: Having a credit score can be great if you want to buy a house. Most of the other things you can do with a great credit score are lousy. If you're worried -- as you should be -- that credit card use will hurt your financial well-being, then don't use one and don't let anyone tell you you won't be able to buy a house because you aren't buying yachts for Visa's executives. Instead, talk to an FHA counselor or loan officer at a small local bank about qualifying for a home loan through manual underwriting.
Take the first steps to building your portfolio.View Course »