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They come from two very different worlds, your credit score and Goldilocks. One comes from a world of fantasy; a world where bears have houses and armchairs and porridge. The other is from a world that is all-too-real, and has implications for almost everything in your life.
However, your credit score and Goldilocks genuinely do have something in common: they both like things to be just right.
How does this apply to your credit score?
We all know the importance of things being “just right” in the story of Goldilocks, but the link to your credit file is a little more opaque – so let’s look deeper into this.
There are two reasons that you may not experience a good credit score that infringes your ability to obtain credit:
- Poor financial management. This is by far the most common reason your credit score may be low. Credit defaults are caused when you fail to make a payment to a creditor; they are very common for people who have struggled with debt issues in the past. Other elements of poor financial management include high levels of debt, having a large number of credit accounts open at once, and similar examples. When most of us think of a bad credit score, we turn to the “poor financial management” reasons as the likely cause – but this is not the only reason a credit score can be low.
- No financial history. While less usual, it is a known fact that little to no financial history can impact your credit score. Superficially, this seems odd; if a person has no financial history, no debts, are thus clearly living within their means means and managing their finances well – why wouldn’t this result in a good credit score? After all, a credit score uses past behavior to predict how people will manage finances in future; if someone has never needed to borrow due to good financial management, surely that’s a plus point? Unfortunately, financial institutions disagree: rather than seeing this as a positive, they see it as a negative. That’s because the lender cannot use past behavior–because there is none–to predict future patterns.
It should now be becoming clearer how Goldilocks and credit scoring is related. Goldilocks wanted the right size of armchair and temperature of porridge, but your credit score wants something even tougher to achieve: people are expected to manage your finances extremely well, never obtain defaults, always pay bills on time, but also use credit. You have to get it just right.
How does this impact your financial management?
The most important point to keep in mind is that your credit score reflects how much you use credit. Using too much (or worse still, default on it) will negatively impact your credit score. However, if you use too little credit, then your credit score will also be negatively impacted. Here’s how to manage this across a number of common financial scenarios:
If you are debt-free and managing your finances well, then you may not have a need for credit – but you should still use credit. There are a variety of ways to do this. For example, if your score is relatively healthy, then you can apply for a standard credit card, spend $50 per month on it, then pay it off in full to ensure you are not charged interest. If your credit score has already been adversely affected by your under-utilization of credit, then you can read this review to learn more about secured credit cards and how they can help you build your credit in a healthy, sustainable way.
Caution is required, alternatively, if you are in debt and struggling with your financial management. The first priority is to ensure that you do not sustain a default on any lines of existing credit. If you cannot meet a minimum payment, then talk to your creditors in an effort to prevent a default from being applied to your file. However, if you wish to build your credit score in an effort to help recover from your debts, then you will still need to use credit to do this. Again, you have a number of options to do this; secured credit cards are a good choice if your credit score has already been harmed, or you could apply for a standard credit card if your score is still managing to stay relatively positive.
Isn’t it unfair that people are effectively punished for managing their finances well?
Frankly, yes. The idea that not needing to use credit is somehow negative is a strange one. But it’s also possible to see how this decision came to exist.
As mentioned, your credit score is a device that financial institutions use to judge how you will act in the future, based on your past behavior. Many people experience this in a negative sense; i.e. their credit score is bad because they have gone into debt or incurred defaults. This makes sense to an extent. When lenders provide funds to individuals, they have to base their decision on something, and although credit scoring is far from perfect, past behavior is a decent enough indicator. If someone has struggled with their finances in the past, it’s likely they’ll struggle in the future.
The issue is trickier when considered in terms of a lack of past borrowing, but also understandable. Think of it like this: who would you rather lend to? The friend who has never borrowed money from you before and whose financial status you’re unsure of? Or the one who has borrowed and repaid promptly? There’s benefits to both, but you’d probably prefer the latter, as their record indicates they will repay. This is why credit scoring can be poor even if the reason someone has never borrowed before is actually positive; i.e. they have managed their finances. Is this ideal? Not particularly, and if you find yourself in this situation, having to borrow just for the sake of your credit score seems incredibly alien – but it is possible to at least understand why credit scores work this way.
Bottom Line for Building a Good Credit Score
The connection between a fairy-tale and your real-world finances may seem like a stretch. But having read through the above, you should now understand how they relate. While it may sound odd for both over-utilization and under-utilization of credit to be a bad thing, this is nevertheless how the financial industry works. By ensuring that you get your credit score management “just right”, you should be able to enjoy a happy, well-managed financial outlook in the future.
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