Credit history is one of the most reliable, commonly used indicators to evaluate an individual’s overall “financial health.” Having stellar credit can mean lower interest rates on loans, access to better credit cards and even home mortgage approval. But good credit won’t help you with every financial issue. Some longer-term financial goals can’t be boiled down to a three-digit number.
What goes into credit, anyway?
Before diving in, it’s important to understand how your credit score is created in the first place. A credit score is meant to provide a one-number snapshot of a person’s overall credit health. It’s generated from information on your credit report. FICO generates the most commonly used credit score, which is based on five variables:
- Payment history — 35%
- Amounts owed — 30%
- Length of credit history — 15%
- Mix of credit accounts — 10%
- New credit inquiries — 10%
Combined, these numbers are meant to determine a person’s eligibility for a new line of credit. Understanding this process can make it easier to grasp why certain financial tasks act independently of your credit.
1. Building an emergency fund
Building an emergency fund is about saving responsibly, and good credit can’t help you do so. If you’re facing unemployment, a medical situation or a home-repair dilemma, paying for those expenses on a credit card is only going to take you so far. People with ample emergency funds can forgo (or at least limit) running up credit card charges and accumulating interest on that debt.
Make a habit of allocating a fixed amount of income every month to an emergency fund. For instance, you can set up automated deductions that send money to a dedicated account. Saving is often most easily done in the background, and you’ll be happy the money’s there when you need it most.
NerdTip: Most financial experts recommend having an emergency fund that covers all expenses for three to six months. This provides a security blanket, giving you time to get back on your feet during a financial setback.
2. Planning for retirement
Planning for retirement involves growing savings with long-term consideration. Having a good credit score isn’t going to make a difference to your lifestyle in old age if you’re not consistently contributing to a retirement account. This is where discipline matters, and those who are able to maintain saving over spending will be in a better position when retirement rolls around.
If you’re just getting started with retirement saving, consider contributing to your company’s 401(k), especially if your employer offers matching funds. If that’s not available, perhaps look into a tax-advantaged retirement account like a Traditional IRA or Roth IRA. Even if you’re not ready to start saving yet, it’s smart to know your options.
3. Getting traditional life insurance
Your good credit typically won’t improve the life insurance rates you’re quoted. Having good credit doesn’t necessarily increase your life expectancy, and therefore shouldn’t decrease your premium. Still, having bad credit can affect eligibility. If an individual has an open bankruptcy, this will often lead to a denial of coverage. Likewise, some life insurance providers may adjust rates for exceptionally bad credit. If you’re already within the range of average credit, though, increasing your score will not generally correlate with a better deal on life insurance.
The bottom line
It’s always better to have good credit, but financial well-being is much more about considering long-term planning. Paying attention to your credit is smart, but there’s no replacement for establishing solid financial habits all around.
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