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By Dr. Rikki Racela, WCI Columnist
Early in my financial education, I recall listening to Jim Dahle lament that the first WCICON in 2018 could not be paid all on a credit card. If memory serves me correctly, Jim had used a Capital One Cash Rewards card, and he was a few thousand dollars short of paying for the whole conference on it. When he asked for a credit limit increase, he (THE Jim Dahle, THE White Coat Investor, the legendary financial educator who, at one time was the seventh-most prolific Boglehead forum commentator) was rejected!
How could this be? At first, this would seem like a sign of the financial apocalypse. Why would a successful physician, business owner, and financially literate individual who teaches personal finance be deemed not worthy by Capital One? At the same time, why would I, who was listening to his podcast to learn more about personal finance and investing, have the same Capital One card as Jim and yet have a higher credit limit that had been granted multiple credit increases in the past?
The reason I can claim my credit score could be higher than Jim's was born out of true painful financial humiliation, when, in front of my wife, the prospect of buying our dream home was crushed. I have written previously how I learned how my own mother had opened up multiple credit cards in my name and ran up $31,000 of credit card debt. I only found out about that after the loan mortgage officer told my wife and I that we, in no way, would be given a mortgage. Not just from Chase but from any bank.
With my wife screaming in the lobby of Chase bank asking me what had happened, I was beyond peeved. My credit score was in the 500s. At the time, that meant nothing to me except knowing that I was the reason we could not get a mortgage. Instantaneously, the credit score became the barrier for me attaining my dream of owning a home, saving my marriage from the scorn of my wife, and becoming financially stable again. I didn’t see the credit score as just a credit score; I had framed it as a voodoo doll embodying my dream home, my marriage, and my entire financial life. With that frame, how could I not obsess over it?
First, though, let's talk about credit scores and how they're tallied.
Getting Your Credit Report and Credit Score
After the painful denial from Chase bank, I immediately got to work. Seeing my distress and our marital fight, the mortgage officer was kind enough to provide a copy of the credit report that he had run. I thank him immensely, because, although creditors are required under the Equal Credit Opportunity Act (ECOA) to cite reasons why you might be denied credit, they are not required to actually give you a copy of your credit report.
If he had not given that to me, I would have had to go to www.annualcreditreport.com to get a free copy of all three of my credit reports. That’s right, you actually have three credit reports reflecting each of the three major credit bureaus: Equifax, Transunion, and Experian. Because they are each separate, it is common that one report in one credit bureau is different—at times drastically—from the other. When you go on www.annualcreditreport.com, you will have the opportunity to get all three credit reports for free.
Take note: Around 2014, there were heavy advertisements for freecreditreport.com (I still remember the jingle in the ad!). As I researched that site, I discovered it only gave you your Experian credit report for free. But this and other websites that advertise a free credit report are trying to sell you a credit monitoring service. Do not fall victim to freecreditreport.com and other advertising websites that fool you into thinking you’re getting a free credit report; they are advertising to you. The main government-sanctioned website is www.annualcreditreport.com (Congress first made it required by law for credit bureaus to provide free yearly credit reports to citizens). Use this one.
What Is a Credit Score?
After doing my research, poring over dozens of resources, and looking over my own credit report, I learned possibly everything one could know about credit scores without actually being in the business of calculating them. The first basic question is this: What the heck is a credit score? Why would lenders care so much about them?
Simply put, it is a quick way to gauge how reliable you are to pay back a lender. Just like when my wife and I walked into Chase bank asking for a mortgage, the quickest way for the loan officer to know whether he could safely hand us over a million bucks and get paid back with interest was to check our credit scores. Immediately, a loan officer gets a score based on years of intense research on who pays back loans and who doesn’t. FICO is short for Fair Isaac Corporation, the main company that developed this score. Not only had FICO consolidated existing research of citizens’ ability to pay back loans, but it also conducted its own extensive ongoing research.
The founders, Bill Fair and Earl Isaac—an engineer and mathematician, respectively—were doing research at Stanford when they thought about starting this company. FICO was founded in 1956, and since its inception, it has continued to do ongoing research and come out with new upgraded versions. The latest iteration is version 10.0. The range of credit scores goes from 350-850. Depending on the version you use, the scores can differ slightly. But it is like most games; the higher the score, the better.
More information here:
Elements of the Credit Score
There are five main elements of attaining a dominant credit score, listed in order of importance:
- On-time payment history
- Credit-to-utilization ratio (I know, sounds fancy)
- Length of credit history
- Credit mix
- Recent “hard” credit inquiries
Let's go over each element and how my actual credit report reflected each one.
On-Time Payment History
This counts for 35% of your overall score, and it is the most important contributor percentage-wise. So, if you don’t do anything else, please pay your bills on time. In terms of my own credit report, my payment history was squeaky clean, and luckily, my mother was still making the minimum payment on the credit cards that were in my name. However, my wife's credit report showed a late payment on one of her student loans from three years earlier.
I remember the incident well. We had placed those loans on what was called, at the time, a “Residency Hardship Deferment.” Due to low income as a resident, student loans could go into deferment for three years, and the subsidized portions of the loans did not accrue interest. Well, when three years were up, you had to start paying. I had the foresight to put our Sallie Mae and one of the My Campus Loans into repayment. Unfortunately, I did not realize that my wife had two separate loans within the My Campus Loan website. I put in for payment for the one loan but not the other. In my defense, mycampusloans.com was so badly laid out and the website was slower than molasses that it was not obvious that there were three separate loans under this company. Anyway, the first month for one of those loans went late.
However, all was not lost. When I saw this, I put in an inquiry to have this information removed by going on each of the credit bureau's websites to outline our case. They responded that they do have to report honestly on what lenders report to them, and they recommended we contact the lender directly to remove this reporting. When my wife called My Campus Loans, the missed payment was removed, and it no longer appeared on her credit report. Even if our attempts were not successful, this ding to our credit score would not have been huge, as her score only rose 10-15 points after the removal. Despite on-time payments accounting for 35% of your credit score, the ding on the score is proportional to how many missed payments you have and by how long. In this case, it was one payment 30 days past due. If it were multiple payments missed going into 60, 90, or 180 days past due, the score would have precipitously dropped. Finally, any missed payments start hurting your score less and less as time passes, and by year seven, it is no longer reported.
It really makes sense why this would count for the biggest portion of your credit score. Obviously, people who don’t pay their bills on time are the type of borrowers who aren't exactly seen as reliable.
This is what really hurt me. This accounts for 30% of your total score. Although it sounds fancy, it is exactly as it sounds; it is the comparison of how much credit you are using compared to how much credit you have available. The more credit you have open but the less you use it, the higher your score. I had five credit cards on my credit report with balances maxed out on all of them, all totaling around $31,000. My total credit I had open included the $31,000, plus another credit card that I legitimately opened on my own back in medical school, a Bank of America AMSA card (the American Medical Student Association—yes, credit card companies hit up medical students early too and I got a free copy of Netter’s to open it). It had $10,000 of available credit. That made my credit-to-utilization ratio about 75%. Not good.
This may seem like a unique metric to be a huge part of your credit score, but when you think about it, this makes sense. If somebody has a lot of open credit—like millions of dollars worth of credit cards they have at their disposal—but don’t carry a balance, a lender might conclude, “Man, other lenders must really trust them because they have millions of dollars of credit available and minimum to no balances on them! That means they pay their bills on time! Here you go, potential borrower. Take my money!”
Length of Credit History
This accounts for 15% of your credit score. The longer your credit cards and other forms of credit are open, the higher your credit score. This brings up a common misconception Americans have regarding credit cards. Many people think they should close credit cards if they are not using them, but you absolutely should not do this. This will shorten the length of your credit history and ding your credit score. After learning this, I actually kept open all the credit cards my mom opened. Your credit history tells lenders you have been using credit a long time, and this is associated with better borrowers who pay their lenders back on time.
This accounts for 10% of your credit score. As we go through life, most of us are going to easily meet this metric. The different account types include credit cards, retail cards (like a Macy’s store card), real estate loans (mortgages), and open installment loans (student loans and car loans, including car leases). With a diversity of account types, this is a metric that FICO found helps identify reliable borrowers. But wait a minute—what if I paid off my student loans? Does this mean my credit score goes down? It doesn't—well, not immediately at least. Accounts in good standing usually stay on your credit report for 10 years after they are closed/paid off, so this will still keep your credit score high for at least a decade after payoff.
Recent “Hard” Credit Inquiries
This also accounts for 10% of your credit score. When you apply for credit, like a credit card, the lender usually asks for a copy of your credit report, known as a “hard” inquiry. This will be reported on your credit report, and the more hard inquiries you have, the lower your score will be. Why? In FICO’s research, it showed that when some borrowers had a lot of hard inquiries, it was because they were in financial distress. So, they kept applying for credit. Also, many times it indicated that these borrowers kept getting denied credit by lenders for whatever reason, pointing to an unreliable borrower. Luckily, if you are applying for something like a mortgage—even if you've applied a number of times—these hard inquiries are considered a single inquiry if done within anywhere from 14-45 days (depending on the type of FICO scoring model being used). After two years, a hard inquiry will fall off your credit report.
How Did I Increase My Credit Score?
If I had such a crappy score in 2014 when Chase bank wouldn’t offer me a mortgage, how could I possibly be writing this article and claim that I have a higher FICO than Jim Dahle? Well, I mentioned how I framed my credit score previously, and now armed with the information I just laid out to you, I set out to deal with the dings in my credit report while taking advantage of the system.
First, I put out a fraud alert and froze my credit shortly after my Chase bank mortgage meeting. I sent a dispute to all three credit bureaus regarding the credit cards opened in my name that I hadn't actually opened. Happily, all three credit bureaus removed the negative information on four of those credit cards. They had recommended to me to close them. But the amounts totaled $14,000, and since I could afford it, I paid off the balances and kept these cards open. Therefore, I could use them to better the metrics mentioned above to increase my credit score.
The fifth credit card was more problematic. The problem was that I had opened up the card when I was in college with my mom’s help. It was a Princeton University Store credit card that was offered to me as a freshman, and I asked my mother to help fill out the application. I did not know that she was listed as a joint account holder on this credit card. When the time came to try to remove this account, two of the credit bureaus did so. But Experian was not so forthcoming because my mother and I were joint account holders. My mom and I were equally responsible for the debt. Further complicating matters, she had claimed bankruptcy in 2013, and this credit card was closed as part of bankruptcy proceedings. Under the comments section of this credit card on my credit reports was the phrase “Closed due to bankruptcy.” In fact, the aforementioned Chase mortgage loan officer had asked during our loan interview if I had ever declared bankruptcy.
Luckily, that “closed due to bankruptcy” comment was easily removed by the credit bureaus since I had not done so. But Experian could not remove this entire account from its credit report. I contacted the lender, Bank of America, to ask for help, but it did not let me off the hook. In the end, I ended up paying the $17,000 of debt on that card to try to max out my credit score. The fact that the card was closed with a balance still hurt my score, but there was nothing else I could do. I also kept this card open, again trying to maximize my credit-to-utilization ratio and my age history.
After dealing with these negative marks on my credit report, I went back to the credit-to-utilization ratio element of my credit score and thought, “Why not open a bunch of credit cards, have a bunch of open credit, and just pay off my credit cards in full every month? Then, after two years, those credit inquiries will drop off, and BOOM! High Credit Score!”
I went to work. Because of my frequent applications for credit and because I surfed Google religiously to learn more about credit scores, I received a huge amount of credit card offers. Many of these also offered an opening bonus of at least $100, sometimes more, if I opened the card and spent at least $1,000 within three months of opening. Many of these credit cards also offered cashback bonuses. Not only would opening these credit cards and not carrying balances on them boost my credit-to-utilization ratio, but I would also get cash back on purchases that I would have made anyway, anywhere from 1%-5%. I should mention a note of caution; there is a weird psychology where, because you think you are getting cash back, you might actually spend more. I actively try not to fall into this mental trap. My wife also opened a bunch of credit cards (only ones with the bonuses) to jack up her availability of open credit and increase her credit score if paid off in full each month.
This next trick will totally blow your mind. With all these open credit cards between my wife and me, we could make ourselves authorized users on each other's accounts. Why would we do this? When you are an authorized user on another person's credit card account, you are listed as having that credit available to you on your credit report, even though you don't actually own the account. You are legally not responsible for the debt on that account, but all the good stuff on that credit card is listed on your credit report—including the on-time payment history and the available credit. Technically, you could not own any credit cards but be an authorized user on several credit cards with large amounts of credit that are fully paid on time every month (good credit-to-utilization ratio), and your credit score would be sky-high.
But wait a minute Rik, doesn't opening all these new accounts ding the length of account history and the credit inquiry elements of your credit score? Yes, they do, but as mentioned before, these elements are not counted as much as your credit-to-utilization ratio, and those inquiries fall off your credit report after two years anyway. Luckily, we were flexible with the timing of our home purchase, so we waited until the majority of our hard inquiries fell off before we applied for a mortgage again.
More information here:
The Financial Fruits of My Labor
After all the drama, where did this get me financially? At the time we applied for another mortgage in 2016, my credit score was above 760, and my wife was in the 800s. I tracked these for free with the free credit monitoring services of Credit Karma and Credit Sesame. Also, many credit card companies now offer a free credit score. We got the lowest interest rates offered by all banks, and we ended up getting a 30-year fixed mortgage at 3.5%, which was the lowest rate at the time. Also, after getting financially literate two years ago, we refinanced our student loans with First Republic and likely qualified for their best rate of 1.95% fixed for five years due to our great credit scores. Finally, in 2021, we refinanced our mortgage to 2.89% fixed for 30 years. Another nice perk is I get to brag about all of it.
Should Jim Be Jealous of My Credit Score?
No, because 1) I have not actually verified that my credit score is better than his, and 2) the ultra-high credit score only helped me accomplish a tiny morsel of my financial goals (getting the best rates I could on my mortgages and student loans). I still did not have a written financial plan. I was far from accomplishing my other financial goals. I was not financially literate. As Jonathan Clements writes in his book From Here to Financial Happiness: “A lofty credit score has become one of America’s most coveted status symbols, which is a little sad . . .because it’s all about borrowing money.” That's just it. Having a high credit score allowed me to borrow money at the best interest rates.
While I had a great credit score, I was still being taken advantage of by a financial salesman who could legally advertise himself as a financial advisor. I was still getting duped into paying $20,000 of whole life insurance premiums a year. I still had a variable annuity within an IRA. I had very inappropriate life insurance policies. I did not have true own-occupation disability insurance. I was paying 150 basis point fees on the 529 plans for my kids. I did not know what asset allocation meant, and I didn't have a proper plan to achieve my financial goals.
And what happened to Jim? He was only denied a credit increase on a Capital One credit card. Plus, think of it like this: Jim Dahle was looked on by Capital One like the NFL combine scouts looked at Tom Brady. Jim was denied credit based on a metric, the credit score, that doesn’t predict financial success. And look at Jim: phenomenally financially literate, crushing his financial goals, and the successful business owner of a website that teaches financial literacy. Despite my high credit score, I am working for him. Jim is laughing at Capital One, just like Tom Brady—who was rated so lowly by the NFL scouts and who was taken Number 199 overall in the 2000 NFL draft—laughs while flashing his seven Super Bowl rings.
The credit score, like the NFL combine, is incredibly myopic. It only measures one part of your finances, your ability to pay back lenders reliably. It does not reflect your eventual financial success. Keep this in mind when you are using my above advice on credit scores. Me, Jim, all of us are trying to be Tom Brady, and we don't care about pleasing the NFL scouts.
[Founder's Note: I don't actually know what my credit score is currently, but the last time it was checked (for our current business credit card with a much higher limit than the Capital One card), it was 821. It's probably similar now, give or take 20 points. I also have no idea (nor do I care) if that is higher than Dr. Racela's. The truth about credit scores is what I told a recent emailer who wanted to get her 790 credit score to be over 800. Once a credit score is “good enough” (about 760), making it higher doesn't make a difference. So what did we do when Capital One wouldn't raise the credit limit on the WCI “convenience card” for the 2018 conference (besides start working with a better bank)? We wrote a check to the conference hotel. How quaint.]
What do you think about my credit score tips? Are they really that important to financial success? Did a high credit score play a huge role in your financial success? How much are you willing to bet that my score is higher than Jim’s? What about yours? Comment below!