Good credit is not the same thing as good money management. You can be great with money, but if you aren’t using credit, you won’t have a good credit score. You can even pay all your bills on time, but if those bills don’t report to the credit bureaus, it won’t help you at all. It seems ironic, doesn’t it? But the truth is that a good credit score has to be actively cultivated, and the older you get, the more not having any positive pay history starts to impact your score.
Having bad credit, or even just fair credit, can significantly start to impact your cost of living, from requiring extra deposits to flat out getting declined for everyday items, like obtaining an apartment rental, a mortgage for a house, a new cell phone plan, or a rental car. Little things start to add up, like paying more for car insurance and homeowners or renters insurance. Many employers even check credit as a measure of trustworthiness these days.
You don’t have to use credit to have a good life, but it’s important to know how your credit score can affect you, so that you have the knowledge to make the best choices to support the life you want. I’ve had a few friends go down the path of Dave Ramsey’s cash-only method of cutting up their credit cards and paying off their debt, and while the paying off debt part is great, some of them have had uncomfortable moments when their circumstances changed. Here are three friends’ examples of the method of only using cash going awry for you to take into consideration.
My friend Mae was 38 when her husband of 18 years, Brian, was diagnosed with cancer. They did all the right things, like have a will and an estate plan, but a year later he passed away and Mae was left with a mess.
Her husband had worked for a beer distributor for several years, so he had a 401(k) that she got, but during the last half of their marriage they had paid cash for everything and almost never used credit cards. The one card they did have was in his name. When Brian died, Mae had to move the accounts into her name, and the satellite TV provider requested a $400 deposit because she had no credit. For a widow with a toddler, that $400 could have gone to many better causes.
Additionally, when she tried to apply for new jobs, she had employers wondering why she had no credit, and then was forced into the awkward issue of having to bring up her husband’s death in a job interview. All while dealing with the loss of her husband and being a single mom to her two-year-old.
Jess’s story is similar to Mae’s. Jess was married for 20 years and then divorced in her early forties. She and her husband had even taught Dave Ramsey’s Financial Peace course at their church for years. All of their income was reported in her husband’s name and they paid cash for everything. When they got divorced, Jess was unable to qualify for an apartment on her own, even though she had received a big cash settlement. She had to ask her ex-husband if he would cosign for her. Luckily he did, and with grace, but her options would have been much more limited if the divorce was not as amicable.
Being an Entrepreneur
My friend Ruth and I chat on the phone about entrepreneurship every week. On our most recent call, she asked if I could help repair her credit. We started talking about her score, which is around 540. She didn’t have “bad” credit per se, but she had no credit in her name. The thing is, as you get older, they are pretty much the same thing. It is much easier to get an unsecured card with a $5,000 limit when you’re 18 than 45, even with the same credit score. Ruth is moving to a bigger city this summer and she wants the best credit when she applies for an apartment because she’s self-employed and her income is variable.
Lessons to Learn:
Notice how women are often more vulnerable in the cash-only scenario? Here are the lessons to take into consideration before pursuing the cash-only method for yourself:
1. Always have some kind of credit in your own name.
A credit card that you put your fixed expenses on and pay off every month is going to be great for your credit score (Credit Karma has a great tool that analyzes potential changes to your score that I highly recommend). By using a credit card for your fixed expenses (utilities are my favorite), the costs are fairly predictable, if that’s all you use it for.
If you have a joint card, make sure it’s reported on your credit report, not just your partner’s. Ideally, it reports to all three bureaus as well.
If you’re an entrepreneur, and especially if you are a solopreneur, your credit may be even more important. If your application for an apartment or a business loan is borderline, your credit can be the deciding factor that tips things in your favor, especially if you recently started your business or went at it full time.
2. Car Rentals and Insurance
If you’ve got bad credit or no credit and no credit card, and you try to rent a car, you’re going to have limited or no options. In the Dave Ramsey world, most of the people are still paying a mortgage so they have fair to good credit. However, if you do not have any credit, and especially if you do not have a mortgage, you will have to allow for a big hold on your cash reserves when you travel. Keep in mind that most car rental agreements say the rental company can immediately charge you for loss of use if you damage their car, and they could potentially tie that cash up for months, rather than having your credit card company going to bat for you.
To compound the car rental problem, if you’re only using cash and not showing a positive pay history on any loan, you can watch your credit score tank, especially if you close your accounts. This also impacts your car and home insurance rates. A person with a score at 520 pays almost twice what someone at 740 pays for the same coverage. Imagine if you put that extra $100 a month in savings — for your whole life!
3. Buying a House
This is where I really think the cash method really falls apart — when you don’t have any history of paying on debt, you have no credit, or your score is low, and you want to buy a house. Unless you can pay for it outright, you look like a big risk for lenders and your interest rates will be substantially higher.
Running the numbers for a fixed-rate mortgage for a $200,000 loan for 30 years is startling. At 3.7 percent, your monthly payment is $736 and your total interest paid is $105,124 over the life of the loan. At 5.7 percent, your monthly payment is $928.64 and total interest paid is $174,312. You pay almost $200 a month more if you don’t have a good relationship with credit. Just to give you an example, if you put that $200 a month in an investment that yielded 10 percent a year for 30 years, you would have $412,587.
What’s the Solution?
How you feel about credit is often a reflection of how you feel about money in general. Do you trust yourself with money and to be responsible with a credit card? It’s okay if the answer is no, but it’s worth asking yourself why this might be the case. If you made mistakes in the past, let them go. Start from where you are and work toward something better. If your credit score is low, figure out why. If you have no credit, start with a credit card with a low limit and work your way up. It might have to be secured, but that’s okay.
The solution for having credit is the same solution that works for living a great life — everything is best in moderation, including chocolate, techno music, and credit cards.