Credit Pilgrim

Navigate Your Credit Successfully

Neal Frankle
I’m Neal Frankle, Certified Financial Planner™. Credit problems are a serious business. In fact they changed my entire family life when I was 16. This site is here to help you repair your credit without getting ripped off. Read my story.
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A Good Credit Score Can Mask a Serious Debt Problem

by Neal Frankle, CFP®

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A good credit score is a source of pride and even prestige. People with high credit scores are sometimes fond of sharing their scores with others. It can be seen as a validation of our worth as borrowers, and at the extreme, as people. That’s because a high credit score indicates that we pay our bills on time, and that we are people who can be relied upon. But it’s also true that a good credit score can mask a serious debt problem.

What a Credit Score Shows

A credit score indicates what your credit experience has been up to this point. The three credit bureaus – Experian, Equifax and Transunion use credit scoring algorithms to compile your credit experience into your credit scores. They measure such factors as your payment history, the number of open accounts you have, the balances that you have on those accounts, and even recent credit inquiries, among other data.

What a Credit Score Doesn’t Show

There’s actually more about your financial situation that a credit score doesn’t show than what it actually does – a lot more.

Here are prominent examples:

Income. Your credit score rates your credit performance. It does not say anything about your income. In fact, it doesn’t even reflect whether or not you have an income. And even if a credit bureau knows what your income is, it will have no effect on your credit score. They don’t even track income in the algorithms.

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Assets. The credit bureaus don’t know or measure how much money you have in the bank or saved for retirement. They don’t even know the value of your house. And even if they did, none of those factors figure into your credit score calculation.

Total-debt-to-income. Since the credit bureaus don’t know what your income is, they don’t know how much total debt you owe in regard to your income. You could owe $100,000, and have an income of just $25,000 per year. That would indicate a distressed situation, but you might still have an outstanding credit score.

Debt-to-income ratio. Individual lenders track this ratio in determining whether or not to grant you a loan. It is your total monthly debt payments, divided by your stable monthly income. The credit bureaus don’t know if this ratio is 20% or 75% or 200%.

In theory at least, you could be in a very bad position in all four of the above criteria, but still have a good credit score.

Don’t Get TOO Excited Over a High Credit Score

Considering the factors above, it’s important to realize that your credit score only evaluates your credit. It virtually ignores your income, your assets, your total-debt-to-income, and your debt-to-income ratio. That means that a stellar credit score doesn’t necessarily mean that you’re doing a similar good job in managing your finances overall. It just means that you have good credit, and nothing more.

There’s another factor to consider: your credit score can and does change over time. The 750 credit score that you enjoy having now, could drop to 650 just by missing a couple of credit card payments. A credit score is every bit a moving target.

A High Credit Score Can Hide Unmanageable Debt

Here’s where the situation gets a little bit creepy. You can have an excellent credit score, at the same time you have run up unmanageable debt. In other words, you could be on the verge of default, and still have an exceptional credit score.

How can that happen? Let’s say that you have a deep credit profile. You have a large number of both open and paid loan accounts, and you’ve paid every one of them on time for the past decade. You also have $100,000 in available credit limits on your revolving debt. Your credit utilization ratio – that’s your total outstanding revolving debt, divided by your total credit limits – is 50%. That’s not great, but it’s not bad either.

As a result of the above factors, your credit score is a very impressive 785.

But apart from all of that good news on the credit front, there are some less settling facts in the rest of your financial life:

  • You owe $50,000 in revolving debt (that’s your 50% debt utilization ratio)
  • Your income is $40,000 per year
  • Your house payment is $1,250 per month
  • You have $400 in the bank, and no investments or retirement savings
  • 70% of your income is going to pay fixed expenses – your house payment, plus debt payments, including credit cards

Do you see what’s happening here? Though you have an outstanding credit score, your overall financial situation is incredibly precarious. You’re a missed paycheck away from defaulting on your loans, and you have no resources available to back you up.

But in spite of all that, your credit score continues to signal that “everything’s fine” in your world. But you know otherwise.

What to do About a High Debt Problem

What makes this whole situation even worse is that people often carry on in this exact situation for months or years in order to protect their high credit scores! They will avoid getting professional help to deal with their debt problem, in order to avoid damaging the credit score.

If the situation comes close to describing yours, then you are technically bankrupt. There is probably no way that you will be able to work out a solution on your own. The most that you can do is keep the current situation afloat for as long as you can.

This is a textbook case of where a good credit score has completely hidden the fact that you are a train wreck in regard to the amount of debt that you owe. You can barely service the debt, let alone pay it off.

This is when you need to seriously consider getting legal help to deal with your debt situation. In truth, your credit and your credit score are meaningless at this point. You have to confront the debt problem, otherwise you’ll be stuck in nothing better than a financial holding pattern for as long as you can keep things going. And if you are in this situation, it’s only a matter of time before your credit score catches up with you. That’s why it’s important to address these problems fast – while you still have a good credit standing.

There are ways to reduce and even eliminate this kind of debt burden. That should be your priority. A credit law firm can help you to get out of this kind of debt in the shortest time possible, as well as minimize lingering aftereffects.

You owe it to yourself to fix your debt problem, which may mean your credit score takes a hit. That’s OK. Once your debt problem is remedied, your credit score will begin to rise once again. And it will do so without all of the underlying debt that causes so much stress in your life.

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