Your credit reports and credit score can’t decide your credit profile completely. Your real life ongoing debt scenario impractically not reflected by your credit report!
If you think that reaching a top credit score will solve all your debt problems, then let me remind you that even with good credit scores, quite a number of Americans are struggling with debt!
To understand why, read on!
Consider this small example of these two men, X and Y.
X has a credit card with $10000 credit limit with an outstanding balance of $4,000. On the other hand, Y has a card with a limit of $2000 and an outstanding balance of $3000.
X’s credit utilization ratio or debt-to-credit ratio is 40% (which is not so bad), and Y has maxed out his card! So, it is pretty obvious that X will have a better credit score than Y because a good part of credit score depends on the utilization ratio. But you can’t readily decide who is more creditworthy, can you? Because X has more debt than Y!
But one thing we can be sure of is that X can handle his debts quite well, but Y can’t, because X remains within his means while Y is a reckless spender and crossed his limit!
Let’s see why sometimes credit score and credit report doesn’t run parallel to your real life debt scenario!
What is a credit score and how is it calculated?
You can pretty well say that your credit score is the number that decides how well you handle credits!
But that’s not all. All financial institutions and credit bureaus use their own methods for calculating your credit score, which is usually based on the generic FICO scoring model!
On top of that, different scoring models are used for different purposes by different bureaus!
For an example, while lending out an auto loan, the banks will contact their own preferred bureaus where Experian will use FICO auto scoring models 8 and 2, Equifax will use the models 8 and 5, while TransUnion will use 8 and 4, to decide about a person’s credit worthiness!
The same thing happens for other lending decisions!
Moreover, it’s not only credit score that is used to see whether or not a bank will lend you a loan. Say in Georgia several other things are scanned before the lenders give out a loan!
Let’s see why sometimes people with good credit have huge debts:
The human psychology is vast to understand. When people reach a good credit score and touch a good credit profile, they feel they are invincible to debt!
But little do they know that even a small wrong action can bring them under big feet of debts!
One such devil is the credit card.
A good credit score means you can get a good credit limit. A good credit limit means good chances to incur more debt unknowingly.
So, previously, if you had a $2000 limit card, you felt pretty sad and had to do your spending within that limit. Now if the bank got happy and increased your limit, then there is a high probability that you will spend more. Along with if there’s no increase in your income, then you are ditched!
Hence as your credit score increases, chances of taking out more debt also increases!
How can people with good credit score fall into big debts?
The first thing you get access to with an excellent credit score are opportunities to take out big loans with good interest rates. Also, don’t forget those sleek credit cards with high limits!
The truth is you can now dream big!
You can easily get good mortgage loans for any second home you are planning to invest on. You will also be able to take out low-interest auto loan for an expensive car.
Things are all different and beautiful with above 750 credit score!
But there’s one small problem. You are practically opening yourself to big debts!
I would want to quote this small paragraph from a report published by Urban Institute in 2013 called Debt In America. Even though the report is 4 years old, still it’s not that old to be thrown out!
The report goes:
“In September 2013, average total debt per American with a credit file stood at $53,850. People with mortgages hold far more debt ($209,768) than those without mortgages ($11,592). But not everyone carries debt. Twenty percent of Americans with credit reports do not have any recorded debt.”
Things got worse 4 years later in 2017. There has been a total of 120 billion dollars increase in credit card debt among American households, from 2013 to the second quarter of 2017!
So that’s the story of debt in our country!
Now comes the medical debt:
This is something that may come as a big surprise to anyone at any point of their life irrespective of how good credit score they have!
Medical costs in our country are seriously high. A normal C-section can cost about $10K. People sometimes avail medical tourism to avoid medical debt in our country.
So, anyone with a balanced financial life can suffer from a huge setback if any sudden medical debt is incurred!
To be practical, having a good credit score can’t help anyone with medical debt!
Some measures to keep intact good credit and low debt:
- Always go for debts that you can afford. Don’t get lured by your credit score.
- Don’t think you can increase your spending habits with an excellent credit score. There’s always room for betterment!
- Always do a bit of math, when you go to increase your limit on credit cards!
- Avoid living paycheck to paycheck. Try to have emergency savings always!
- Don’t forget to consult a financial counselor before making expensive decisions! If your debt seems to bother you much, then choose your suitable debt relief option!
Author Bio: Andy is a contributor at Oak View Law Group and contributes specifically on personal finance topics. You can also find him fielding queries based on money management topics on various online communities and social media platforms.