FICO scores range from 850 to 300 – exceptional to poor. Of course, if you tried to get a bank loan with a credit score of 300, you’d be laughed out of the lobby. So why is 300 a perfect credit score? Let’s look at some data to answer this question.
The key inputs to your credit score include payment history, debt levels, and debt type.
- 35% = Payment History
- 30% = Debt Level and ratios
- 15% = Length of your credit history
- 10% = New debt
- 10% = Debt type
Do you notice a theme? The key word is debt, and it drives your credit score. It has nothing to do with your income, savings rate, asset level, or net worth.
Consumer debt is staggering and growing. Banks, credit card companies, and other lenders have little incentive for you to reduce your debt level because the more you owe, the more they earn. Credit card companies typically charge 16% to 17% interest rates, and with rates at 16%, why would lenders want you to stop borrowing money?
The current US public debt level is $31.46 trillion, which jumped significantly after COVID.
Debt is a four-letter word that will hold you back from reaching your dreams. The Bible taught us this centuries ago: The borrower is the slave to the lender. ~ Proverbs 22:7.
Why not use your resources to eliminate debt rather than increase your credit score by borrowing money? Reducing or eliminating your debt is financially freeing. A monthly payment for a $30,000 auto loan with a rate of 7% is $594. If you invested this same amount at 7%, your balance could be worth $42,526 after five years.
Here are a few suggestions to help you reduce your debt:
- Debit Card. Use your debit card instead of a credit card. Your payment will be deducted directly from your checking account. If your checking account balance is $500, your spending limit is $500.
- Used Car. Buy a used car with cash because it depreciates when you drive your vehicle off the dealer’s lot.
- Community College. Attend a community college for two years and then transfer to a state school. The annual tuition to attend SMU is $80,530, so two years of study will cost you, before room and board, $161,060. Attending Austin Community College costs $6,612 – a difference of 92%!
- Home Purchase. Buying a home with 100% cash is challenging. If you purchase a home with debt, limit your mortgage payment to 28% of your income. For example, if your monthly income is $10,000, your payment should be $2,800 or less.
Your credit score will disappear once you stop using credit cards and other debt tools. It will take about six months for this process to occur. No debt. No FICO.
If you can’t afford it, don’t buy it. However, most don’t adhere to this philosophy. If we want it, we buy it – regardless of the cost. Before you decide to buy, calculate the cost. If you have the money, then buy it. If you fall short, save until you have the resources to do so.
Good luck and happy saving!
When buying a used car, punch the buttons on the radio. If all the stations are rock and roll, there’s a good chance the transmission is shot. ~ Larry Lujack
August 15, 2023
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.
Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor. Prices and yields are for today only and are subject to change without notice.
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