Are You More Interested in Having a Good Credit Score or Being Debt Free?
By Caitlin in Credit
We discuss credit scores, credit reports, and credit rating a lot. Along with topics like getting out of debt and budgeting, they are probably the most talked about personal finances topics out there. There are two reasons for this. One, we’re told by lenders, banks, creditors, and credit agencies that credit is really important. Two, credit is actually really important in certain situations.
So when does your need for a great credit history and a high credit score go too far? Our guess, when your credit score is high but you’re swimming in debt.
What Affects Your Credit Score?
Your credit score is calculated based on 5 categories: history of payments (35%), total debts (30%), credit length (15%), diversity of accounts (10%), and finally recent inquiries (10%). How you manage each of these categories dictates how high or how low your credit score is going to be.
Each of the categories is weighted, for example, whether or not you make your payments on time is significantly more important than the recent credit inquiries (or credit pulls/checks, click here for more information) that show up on your credit report.
Who’s Interested in Your Credit Score?
Your credit score, a short three digit number represents you and your financial habits. If you have “bad” financial habits your score will be affected and if you have “good” financial habits your score will be affected.
So who decides what is “good” and what is “bad” when it comes to financial habits? That would be the people who provide loans and credit cards and the institutions that track it all. Lenders, creditors, and the credit reporting agencies say what constitutes good credit. If you’re going to deal with any of these institutions, then the health of your credit is important and unfortunately there isn’t any way around it.
Click here to check out our Credit Score Breakdown infograph.
Do You Want a Good Credit Score?
If you want a good credit score so you can get approved for the loan and credit products you want and need, then you need to take on debt. This is a detail that a lot of people either don’t know, don’t want to admit, or really don’t like. Credit scores are based on your ability to handle being in debt.
If having zero debt is your number one financial goal and you’ve been able to achieve that goal, that’s amazing and we can’t congratulate you enough. But guess what? Your Credit score might not be as high as if used to be or as high as you want it to be. It probably won’t be horrible, but it’s also definitely not going to be super high.
Being in pursuit of a high credit score is not a bad goal, we just want you to make sure you understand what’s going on and that racking up tens of thousands of dollars worth of debt just to have a high credit score is not the best idea.
Credit vs. No Credit
You can live your financial life two ways, with credit or without credit. Both options come with pros and cons and both options are completely feasible. It simply depends on how you see your life panning out and what types of investments or purchases you hope to make and how you plan to make them.
If you want to purchase a house, like the majority of Canadians, it’s very likely that you’re going to need a mortgage to do so. In this case, to get an affordable mortgage you’re going to need a credit history and a good credit score. This means you’re going to need to use credit products and potentially take on debt in order to achieve the illusive high credit score.
If you’re more of a renter (keep in mind that landlords almost always perform credit checks, therefore a credit history is necessary) and plan on purchasing your next vehicle with cash, then your credit isn’t as important.
How to Balance Debt Management and Credit Score Health?
Whether you’re in debt and want to become debt free or are just looking to build your credit score, here’s what you need to know about managing debt while trying to have a good credit score.
Credit Utilization
Above, we mentioned that your credit score is calculated based on 5 factors and that your history of payments carries the most weight. The second most weighted factor in the calculation of your credit score is the total amount of debt you have. It’s this factor that you need to pay attention to if you’re looking to maintain a healthy credit score while still trying to pay off your debts.
You should have a credit utilization (the amount of debt you have compared to your available credit) that is no more than 30%, but less than that is even better. Here’s the problem, having no credit utilization is not a good idea and will negatively affect your credit score.
Bottom line is, you need to figure out for yourself, based on your current debt levels, how to maintain a credit utilization ratio that will allow you to paid off your debt and hopefully maintain your credit score.
We understand that this is a lot of information to process and that some of it may seem counterintuitive, so here’s a quick recap of the most important points:
- Paying off your debt is always a good idea.
- Maintaining a high credit score is also a good idea but not at the expense of your debt management plans.
- To maintain or build a good credit score you absolutely need to:
- Make your payments on time all the time.
- Make sure your credit utilization is less than 30% but more than zero
It’s important to keep in mind that no one really needs a credit score that’s 850, especially if their swimming in debt.