Credit Scores and Early Retirement

Good Credit can make Financial Independence a little bit easier

It is very difficult to get by with bad credit or no credit score.  Yes it can be done, but it requires a lot of extra work (and usually lots of cash in the bank).  Going on a vacation with no credit cards can be frustrating because of holds hotels can put on debit cards that can lock up available cash.  I am not sure you can rent a car easily without a credit card either.  For most of us, we are better off understanding how credit scoring works, monitoring our free credit report (you are allowed to get all three major credit bureau reports for free each year), and even factoring in its use in some of our financial decisions.  If you are afraid to have credit cards because you think you will spend too much then I would say that lack of discipline will make it more difficult to reach early retirement.  The same principles of saving versus spending on your budget apply to credit card usage.

The people that can get loans at 0% for a new car would obviously pay less than someone that can only get a 5% car loan.  However, would someone that retired early want to buy a new car?  Probably not; their frugal way of life would involve paying cash for a reliable used car.  But at least they have the option of low cost financing if they so choose to their manage cash flow with some low cost debt.  Another comparison is credit cards.  Those with high credit scores can open new cards just to get bonuses and not have to worry about ruining their borderline credit.  You can’t do travel hacking with a bad credit score because you wouldn’t get approved for any cards with a score below about 720.  Even if your score was at 720, opening new cards makes you score temporarily drop 3-5 points, so you could only get one card.  I recently opened 5 new cards for the sign-up bonuses and my score didn’t even drop under 800.

Let’s start with understanding how credit scores work.  The biggest two factors in credit scores are payment history and amounts owed.  Late payments are the biggest problem I see when I look at someone’s credit.  Severely late payments (more than 90 days) hurt even more!  If you have never had late payments, collections, or a bankruptcy your credit is probably above average.

If you pay off the balance every month then your score is probably pretty good (over 720).  An important thing to know is whether or not you pay the balance in full, the credit scoring model sees any statement balance and considers that a balance on the card.  That means if you charge $300 on a card and wait until you receive the statement to pay it, then the $300 will show as a balance on your credit report.  This would only be a concern if you have several cards not paid in full or if you use multiple cards for the rewards and have a big purchase coming up (in that case just pay the balances each week or before the statement date cut-off).

It is possible to have very few accounts and have a credit score, so don’t go out and open a bunch of new ones just to try and improve it (in fact your score will go down at first if you try that).  The length of credit history includes the average age of accounts, so adding new accounts will lower that average.  An average age of 6-12 years is considered pretty good by FICO.

FICO score breakdown

Breakdown of a FICO score

Lots of credit inquiries can also hurt you.  The good news is you can still shop around for car and mortgage loans.   Your FICO score will consolidate all of the credit inquires for auto/home loans from a 1 month period into 1 for the purposes of calculating the score.  All of the inquiries will still show up on the report, however.  Inquiries may show up for two years, but they only affect your score for one.  Also,  the other factors from opening a new card should offset the inquiry after a few months, so your score should recover (or even increase) fairly quickly.

Regarding credit reports versus credit scores, let me be very clear.  You are allowed by law to receive each of the three major credit bureau credit reports each year (Equifax, Experian, and Transunion).  They will try to sell you a credit score as well.  That score is not needed to review the credit report.  Annually, you should review the report to look for errors such as accounts that are not yours, bad addresses, etc.  You only need to check your credit score if you have an upcoming large purchase like a house or a car coming up.  I have paid for the FICO score service while repairing credit for others because it is neat to watch the score go up as you work on making changes, but even that wasn’t really necessary.  Go to AnnualCreditReport.com to get the free scores each year (and remember you do not need to pay for the scores).

As a side note, the Barclays Arrival Plus card gives you a free FICO score each month.  I use that card for my regular spending because of its great initial bonus and the 2.2% back when it’s used for travel.

The last part is probably the most important.  Once you understand your credit score, you can plan ahead for your use of credit.  It doesn’t make sense to open a new Kohl’s card to get 15% of a single purchase if you are looking at buying a house soon.  You want to avoid inquires, new accounts, and carrying any balances in that time.  In fact, you should probably never open a store branded card (Best Buy, Macy’s, Kohl’s, etc) as all of the “deals” they send you with special sales and coupons might actually trick you into spending more money.  The retail mantra of spend more save more can be a powerful drug at times.  We have all fallen victim to that game.

Good Credit Opens Up Doors

Now that credit scores make more sense, why do you need a good one?  The obvious answer is it can save you money.  Lower interest rates mean lower payments and less interest paid over the life of a loan.  Great credit means having your choice of reward and travel credit cards.  Feel like opening up a new account to get that $500 bonus?  If you have stellar credit, you don’t even have to think about it.  If you have great credit, you still can do it a couple of times a year.  Bad credit means you don’t have the option and will end up paying more by not getting those bonus miles!

Fortunately, people that can achieve financial independence will have the discipline to repair any blemishes from the past that have affect their score.  Everyone has made mistakes, but time is your best friend when it comes to credit scores (just like with compound interest).  Making smarter choices going forward can lead to a steady improvement in your score.  It is not unusual to have a score rise 50-60 points in  a year if you figure out what was causing the low score in the past (too many inquiries, high balances, late payments, etc.).  Much like planning and organization are important to achieve financial independence, they are also required to ensure the best possible credit scores.  Think before you access your credit, it will help you make sure you keep your score high for when you really need it.

I consider great credit to be 760+ and exceptional credit to be 800 or higher.  You can start getting access to the best rates at around 720, but it depends on the lender and other factors.  Some lenders may want 750 or even 760 for the top tier rates.  Great credit gets you bonuses, special offers, annual fees waived, and other benefits.  Sometimes all you have to do is ask (and have a credit score over 760).

Ebates Coupons and Cash Back

I personally plan to save a few thousand dollars on my next vacation by using credit card rewards to my advantage.

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