Credit Score & Insurance
“Oh for f*ck sake…”
If that was your reaction to the title, we totally understand. Credit score and insurance are two of the most confusing things in personal finance. Here, we will try to demystify both concepts for you in ~1000 words (or die trying).
Credit Score
Credit scores are basically black boxes of dark magic beyond simple comprehension for most people.
Rightly or wrongly, society has evolved to the point where the lack of a good credit score will make your life much more difficult. While we can’t tell you exactly what’s inside the black box, we can tell you all the fundamentals components of your credit score and shine some light on it.
Put simply, a credit score is a number that tries to guess how likely you will repay borrowed money. The FICO scoring system dominates the United States, with a maximum score of 850. Banks look at this score when deciding if they want to lend you money, and how much they will charge you for interest. The lower your credit score, the lower chance of you getting approved for a loan, and the higher interest you will have to pay.
The FICO credit score is composed of the following parts:
Payment history - how many loan payments you’ve made (35%)
Credit utilization - how much money you’ve borrowed (30%)
Length of credit history - how long have you been borrowing money (15%)
Credit mix - how many types of loans do you have (10%)
New credit - are you taking out new loans (10%)
The FICO credit score has its fair share of problems. For example, imagine someone who has $500,000 in the bank but has never borrowed money before. If he wants to take out a loan for a $50,000 car, common sense tells us he is a very low-risk borrower; however, in the eyes of FICO, he has no payment history, no length of credit, and zero credit mix. In this sense, the credit score punishes people who are financially responsible but just happen to not like borrowing money.
So, just how important is a credit score?
Answer: extremely important. If you ever want to take out a loan for a house or a car, then sadly, FICO can make or break you. Here’s an example:
Suppose you have a 730 credit score. You ask the bank for a 30 years fixed rate mortgage for $250,000, and they decide to charge you 3.6%, which will cost you $159,181 in total interest payments. Imagine the same scenario, but this time you started taking early steps to improve your credit score as soon as you turned 18 and ended up with a 780 credit score instead. Because of your higher score, the bank offers you 3.1% for the same mortgage. You end up paying $124,315 in total interest payments.
In this situation having a worse credit score will cost you $35,000… that’s a Tesla Model 3 right there (yeah sorry, you’ve got a Tesla fan here). If your mortgage was $500,000 instead of $250,000, that number balloons to $49,732!
With a brand new Tesla on the line, you might be wondering exactly how you can improve your credit score. The good news is that improving your credit score is very possible, the bad news is that it takes years to make real progress, so get started early. Here are ways to start building your credit today:
Open a no annual fee credit card for small purchases to start building payment history. Remember, always pay it off in full!
If you are under the age of 18, ask to be added as an authorized user to your parents’ or your guardians’ credit card to boost the length of your credit history.
Never, ever, ever miss a payment. Even one missed payment is like dropping an anvil on your payment history.
Lower your credit utilization. Avoid unnecessary borrowings to appear more financially responsible in the eyes of FICO.
Don’t close old credit cards. Your first credit card might be sitting there gathering dust, but closing it can instantly shorten the length of your credit history and permanently hurt your credit score.
(Self-promotion alert) Use the Guardian Credit Building Savings Account to improve your Payment History, Credit History, and Credit Mix while saving money.
Not having an excellent credit score can literally cost you over $100,000 once you start making major life purchases, so please, get started today and don’t waste all that money on avoidable interest payments.
Insurance
This is the last boring segment, we promise. The next section is all about investing but insurance can be incredibly important, so please bear (🐻) with us.
We already discussed having an emergency fund to help you through job transitions or sudden expenses, and most employers offer basic health insurance, so for the purpose of this discussion, we will focus on life insurance. We know imagining dying can be morbid, so we will keep it short.
If you have a family or are planning to have a family, and you are responsible for a significant portion of the combined income, a premature death could leave your loved ones with staggering financial obligations. A life insurance’s main purpose should be to help with those obligations, such as:
Income - Having several months or a couple of years of income available for your loved ones will allow them to focus on grieving and recovering emotionally without having to worry about money.
Debt - Some people choose to buy a policy that pays out enough money to pay off their car, mortgage, and other major debts in the event of their passing.
Education - Given the ridiculous cost of college, some people want to make sure their children or spouse can afford to finish schooling if something unfortunate happens.
How much life insurance you should have is a sum of the above three considerations. If your kids are still very young and your spouse can easily find a job when needed, then several months of income might be all the coverage you need. If you are near retirement with a paid-off house and grown-up kids, it’s not a bad idea to forgo life insurance. Insurance salespeople will argue against what we are saying, but the cost of life insurance is a very real expense. Buying more insurance than you need means less money to save and invest. The commissions of salespeople shouldn’t be made possible by your detriment.
Okay, that’s the insurance segment. See, that was pretty short right?
Up Next…
It’s finally time to talk about the most exciting part of personal finance: investing. Join us as we talk about different types of investments, which ones are right for you, and how to invest intelligently…
