Personal finance

Questionable financial advice: on credit scores

I swear that this is not going to primarily be a personal finance blog.  I just happened upon something else in that arena that I wanted to share comment on so I can hopefully correct bad information.

Of course it’s Mr. Ramsey again:

Dear Dave,

I’m 20 years old, and I’m trying to get out of debt. However, I’m concerned about what might happen when I’m older and don’t have a credit score. My girlfriend says I won’t be able to get a job or rent an apartment without a good one. Is this true?

Ian

Dear Ian,

No, it’s not true. I’m sure your girlfriend is a sweet person, but she has no clue what she’s talking about in this situation.

In either case you can simply explain that reason you don’t have a credit score is because you have no debt. Since you don’t have any debt, you have something known as money. That makes you very stable, and it makes you a fantastic candidate as an employee or tenant.

Listen to me, Ian. I’m a landlord, and if I had my choice between a tenant with no debt and no credit score and someone with a high credit score but lots of debt, I’d take the one who has no debt in a heartbeat. Why? Because that’s the one who is most likely to pay.

Besides, you already have a good credit history if you’ve paid your bills on time. Show them proof of that, if necessary. But taking on a pile of debt to have a high credit score or increase your current score is just plain stupid!

—Dave

See also his blog post here, in which he advises that a credit score isn’t important if you’re out of debt.

Here’s why that’s bad advice:

First of all, I mentioned here that all debt is less than optimal.  I’m working on getting out of debt myself.  But more and more, certain types of businesses check your credit score either as a precondition to doing business with you or as a way to help set your rates.  For example, insurance companies (auto insurance is still mandatory, no?), property management companies (from whom you can rent a place to live), even employers are checking credit as a way to evaluate both how trustworthy you are and how susceptible you might be to bribery from less-than-savory characters.  Back in the day, one of the conditions for maintaining my TS-SCI clearance was a certain level of financial responsibility, commonly expressed in a credit score.   Most places don’t know any other way to evaluate, and are not open to any other way to evaluate a person’s financial responsibility other than a credit score.

That means there’s no “explaining” that you have no debt or alternatives such as showing proof that you pay your bills.  If a company’s policy requires a certain credit score to do business with you, then that’s what they’re going to need and there’s not much they can do about it.  Although Dave might prefer a tenant with no credit score, unless you can rent from Dave, you will probably need a credit score.

Also, simply because you are out of debt doesn’t mean that you have the money lying around to, say, buy a house or replace your clunker of a car.  Guess what you need for those things – financing!  Guess what you need to secure financing – a good credit score!

Finally, creating and maintaining a good credit score doesn’t have to mean taking on “a pile of debt.”  Since I have a decent credit score and excellent cash flow management skills, I may share what has worked for me and what I have seen in another post.

Bottom line – pay attention to your credit score!  It is increasingly the key to being able to move through life financially.

Questionable financial advice: on homebuying

Let me just start off by saying that Dave’s not a bad guy.  He means well and his advice is usually pretty good.  Certainly much better than no advice if you really need to figure out which way is up.

But I do have a couple bones to pick with his “5 Must-Do’s Before You Buy a Home” –

1. Kick debt to the curb and pile up cash.

Sure – this is optimal.  Not going to argue that.  But I completely disagree with the idea that you should hold off building your own wealth (i.e. equity in a home) and continue throwing money at someone else’s income statement until you have competed this step.  Especially considering that it is increasing impossible to begin life without debt of some sort – student loans, auto loans, even a credit card balance to pay moving expenses while you get set up.  If you follow this advice you will not begin to build wealth until very, very late in life.

“Most people don’t wait to have this foundation in place when they buy, which leads to tough times when they face unexpected expenses or job loss.”

Sure – but you can either have those tough times as a renter or as a homeowner with an actual asset to your name.  So this particular point makes no difference either way.

2. Set yourself up to win with a nice down payment.

Again – sure, this is optimal.  Not going to argue that.  But again with #1, you are facing a HUGE opportunity cost if you spend your life getting to this point (and paying thousands and thousands of dollars in rent that could be working toward equity in your own home) before you consider buying a home.

3. Keep your budget conservative.

Now this one I am 142% behind. (Can I even be 142% behind something?  Sure I can!  It’s my blog; I can do whatever I want.)

This is ESSENTIAL.  Figure out how much money you can comfortably commit each month, then use a mortgage calculator using conservative estimates of your interest rate (at least 2% over what you expect to get), insurance, property taxes, PMI, and flood insurance (if you think you need it).

And don’t forget, your new home comes with extra costs like yard maintenance, roof replacement or repair and upkeep for your heating and cooling system.”

Yup.  Don’t forget those things, too.

4. Don’t let emotions rule.

142% agreed here, too.  This goes along with #3 above – figure out your (conservative) budget, aim for lower, but don’t go one penny above what your limit is.  You will be grateful for your self-discipline when those unexpected expenses come up.

5. This is no time to go on autopilot.

This.  Exactly.  When we bought our house, getting the offer accepted was the easy part.  Make sure you know exactly what you need to do, WHEN it needs to be done, and then get it done early.

Other thoughts – 

“All debt is bad debt.”

No.  All debt is less than optimal.  There’s a difference.  All things being equal, you shouldn’t go into debt.  But all things are not equal – sometimes (err … often), the cost of NOT going into debt is far too high.  Examples abound – college (assuming you treat college as an investment and chose a major with good job prospects), cars (you need something safe to transport your family), medical bills (because home births aren’t always the best idea), moving expenses (to get to the job you got hired for after college) … I could go on.

The name of the game is cash flow management.  Figure out what you need, don’t pay more for it than you have to, add up your income, add up your monthly commitments (i.e. payments for things), and use the rest of your money for groceries, gas, and paying down the debt you have.  Being debt-free is a great way to live, and I hope to get there someday, but it’s just not possible to start out that way.

When is it a good time for me to buy a home?

When you can afford it (see #3 above), and when you know you are going to stay in the same place for several years.  There are significant transaction costs to buying and selling a home, so this isn’t something you want to be doing very often.

Take notes from friends and family that have bought houses so you figure out what your must-haves are.  A home is a BIG purchase, so you need to know what things will make it worth it for you to commit to a house.  Do you need a park nearby?  Do you need a particular school district?  Do you need a Starbucks around the corner? (Not that I know ANYONE like that ….) Do you want to be within 3 miles of an emergency room?  Once you find a house that meets all your must-haves that you can afford (see step #3 again – I can’t emphasize how important this is), then GO!

Have fun – enjoy the ride!