Responsible Credit Score Strategies for Young Adults
You Can Improve Your Credit Score and Build Wealth
Yes – you read that title correctly. Mr. ToughMoneyLove is going to discuss credit score strategies. Why? As I continue my tough love campaign against credit score obsession, I have to acknowledge that it is unlikely that readers will choose my path of being completely oblivious to my credit score.
My financial planning FICO strategy is and always has been that if my wife and I work hard to avoid consumer debt and increase our net worth, we will achieve financial success without having to worry about fluctuations in our FICO score. That attitude doesn’t sit well with everyone, particularly young adults who have no credit history or who might have made early money mistakes and now find themselves working to improve a low FICO score. I am sympathetic to that predicament.
So, lets examine some strategies that can help your credit score and preserve opportunities to build wealth.
Strategy No. 1: Ignore Your Credit Score
On the other hand, when I was a young adult, we didn’t have landlords, insurance companies, and employers looking at our credit histories. They weren’t that lazy – they looked at us as a person and what we had done. Now they are that lazy and young adults are the victims of their laziness, so let’s move on to ….
Strategy No. 2: Refuse the Check-Out Line Credit Card Offers
Retail chain stores frequently offer shoppers an opportunity to obtain an immediate 10% discount on a purchase if that shopper applies for that store’s credit card. These offers are quite tempting to young adults (even to wealth builders), particularly if the purchase is a substantial one, such as a kitchen appliance. Moreover, these offers are hard to resist because they are presented at the checkout line. The store knows that you will be in a time crunch at that point and may not pause to consider the full implications of the offer. You may be inclined to get your credit feet wet by accepting one of these offers.
Why this strategy may help your credit score
One of the factors in calculating the traditional FICO score is “new credit”, including recent credit inquiries and new credit cards issued. Thus, each time you apply for a credit card in response to one of these offers, your credit score can be negatively affected, even if you end up changing your mind and don’t accept the card. Another factor in the FICO score calculation is what is called “utilization.” This is the ratio of your actual debt to the credit limit on your accounts. So, assume that you decide to take one of these offers and charge that super-deluxe front loading washer-dryer combination, discounted to $2500. If the retailer issues you a card with a $5000 credit limit, your utilization is 50%. Depending on what other credit you may have, a utilization ratio that high will ding your credit score for sure.
Why this strategy may help you build wealth
It may seem counter-intuitive to suggest that turning down a 10% discount on a purchase will build wealth. But for a young adult new to credit, it likely will. Let’s start by asking ourselves why the retailer would be offering a 10% purchase discount to new card holders. That’s an easy one. They know that they will likely earn that 10% back – and more – from the cardholder. First, they know that a young adult is more likely to purchase a product that he or she cannot afford by tempting the purchase with an immediate 10% discount. Second, the retailer also knows that statistically, 55% of all credit card holders carry balances on their cards. For young adults, that number is a whopping 71%. Therefore, despite your good intentions, it is quite likely that you will eventually charge more on that card, carry a balance, and pay interest that easily exceeds the 10% discount you received. That is not a wealth building strategy. Refuse the offer and you have preserved opportunities to build wealth.
Strategy No. 3: Focus on the FICO Expansion Score
In recognition of the difficulties confronting young adults and others who have no credit history (such as the working poor and the recently divorced), in 2006 FICO introduced the FICO Expansion Score. The FICO Expansion score is intended to quantify credit risk like the conventional FICO score, but using different scoring factors. These factors include bank deposit accounts, payday loans, and “rent to own” transactions. (Just forget those last two factors, will you please?) This means that if you have a checking account with a solid history of deposits and withdrawals, you will do well on the FICO Expansion score. (Of course, if you are a check bouncer, you are in big trouble.)
Recent studies have shown that the FICO Expansion Score is a reliable indicator of credit risk. Therefore, more businesses are expected to look at this score for a young adult when a traditional FICO score is not available. You should take advantage of this trend. Use your bank deposit accounts to build your credit score and grow those accounts to build wealth.
Strategy No. 4: Use a Gas Card
Mr. ToughMoneyLove understands that most young adults will want to establish a more conventional credit score sooner or later, using conventional credit. (Isn’t it sad that consumer credit has become so conventional?) I recommend that you do this with a credit card from an oil company. This helps your credit score because the oil companies report their credit card accounts to the credit bureaus.
This strategy also preserves wealth building opportunities because gas cards self-limit your ability to use them. In other words, you can use the card to fill your tank, allowing you to commute to work and make money. (An always good financial planning strategy.) On the other hand, as long as you don’t get a VISA or Mastercard branded card, you won’t be able to walk into a mall, whip out your Shell card, and charge clothing, electronics, or jewelry that you cannot afford to buy with cash. (I suppose you could try, but the resulting embarrassment may be hard to take.) Having a credit card that can be used only for necessary purchases like gasoline is relatively low risk and therefore preserves wealth building opportunities for the young adult carrying it.
A Final Recommendation
After you have achieved a credit score that is sufficient to qualify your for good rates from your insurance company and mortgage lender, stop worrying about Mr. FICO. Return to Strategy No.1 above and focus on doing the things that will increase your net worth. Do not let your credit score become the number by which you measure your financial success.