The All Cash Method and Your Credit Score
I’ve had a few friends go down the Dave Ramsey path of cutting up their credit cards and paying off their debt, and while paying off the debt part is great, some of them have had some uncomfortable moments when their circumstances change.
I’ve got three stories of the all cash method gone awry for you.
My friend Mae was 38 when her husband of 18 years was diagnosed with cancer. They did all the right things, like have a will and an estate plan. A year later he died and Mae was left with mess. He had worked for a beer distributor for several years, so he had a 401k that she got, but the last half of their marriage they had paid cash for everything and never used credit cards. Of the one card that they did have, it was in his name. When Brian died, Mae had to move the accounts to her name, and the satellite TV provider requested a $400 deposit for an account in her name at the same house.
She also had employers wondering why she had no credit and the awkward issue of having to bring up her husband’s death in a job interview (she wanted to give them a heads up that her credit score was awful).
All while dealing with the loss of her husband and being a now single mom to her two year old.
Even if she had the cash for the deposit, is that the best use of money? I can think of 10,000 things I would rather do than give any more money for already bloated TV costs. As a widow with a toddler, that $400 could have gone to many more life enhancing experiences.
Jess’s story is similar to Mae’s. Married for 20 years, and then divorced in her early 40’s, Jess’s husband ran a contracting business. They even taught Dave Ramsey’s Financial Peace course at their church for years. All of their income was reported in his name, and they paid cash for everything. When they got divorced, Jess couldn’t qualify for an apartment on her own, even though she had a big cash settlement. She had to ask her now ex-husband if he would co-sign for her. Luckily he did, and with grace, but her options would have been much more limited if he had not.
If you’re wondering why the pile of cash didn’t save her, it’s because she had no history of paying on anything and her score was in the 500s.
Ruth and I jam on the phone about entrepreneurship every week. We were on our weekly call last week, and she asked if I could repair her credit. We started talking about her score, which is around 540. The problem is she didn’t have “bad” credit per say, she had no credit, but as you get older, it’s pretty much the same thing (it’s much easier to get an unsecured card with a 5k limit when you’re 18 than 45, even with the same credit score). She is moving to a bigger city this summer, and she wants the best credit when she applies for an apartment because she’s self employed and her income is variable.
Notice how women are more vulnerable in the cash only scenario?
When I asked Mae and Jess what they wish they would have known and what they want you to know, there answers were the same.
Always have some kind of credit in your own name.
I will add this: A credit card that you put your fixed expenses on every month and pay off is going to be great for your credit score (Credit Karma has a great tool that analyzes potential changes to your score that I highly recommend). By using a credit card for fixed expenses (utilities are my favorite) then the costs are fairly predictable and don’t have a way of escaping if that’s all you use them for.
If you have a joint card, make sure it’s reporting on your credit report, not just your partners. Ideally it reports to all three bureaus as well.
If you’re an entrepreneur and especially if you are a solopreneur, your credit is almost even more important. If you’re on the border for an apartment or a business loan, your credit can be the deciding factor that tips things in your favor, especially if you recently started your business or went at it full time.
Car Rentals and Insurance
If you’ve got bad credit or no credit and no credit card and you try to rent a car, you’re going to have limited or no options. In the Dave Ramsey world, most of the people are still paying on a mortgage so they have fair to good credit. They can allow for a big hold on their cash reserves when they travel. Keep in mind that most of the car rental agreements say they can immediately charge you for loss of use if you damage their car and they could potentially tie that cash up for months, rather than having their credit card company going to bat for them.
To compound the car rental problem, if you’re using all cash and not showing positive pay history on anything, you can watch your credit score tank, especially if you close your accounts. This also impacts your car and home insurance rates. A person with a score at 520 pays almost twice what someone at 740 pays for the same coverage. Imagine if you put that extra $100 a month in savings….for your whole life.
Most of the people I know have big dreams that might be impacted by not being able to rent a car. Like the one where all your friends meet up in Santa Fe or Vegas or drive from coast to coast or tour the National Parks? Yeah. Those dreams.
Buying A House
This is where I really think the all cash method really falls apart….when you don’t have any history of paying on debt and you have no credit or your score is low and you want to buy a house. Unless you can pay for it outright, you look like a big risk for lenders and your rates will be substantially higher.
Running the numbers for a fixed rate mortgage for a $200,000 for 30 years, the numbers are startling. (I can see some of you recoiling with fear at that number and some of you thinking that would buy a closet in your market).
At 3.7%, your payment is $736 and your total interest paid is $105,124 over the life of the loan.
At 5.7%, your payment is $928.64 and total interest paid is $174,312.
You pay almost $200 a month more for the choice not to have a good relationship with credit.
Just to give you an example of what would happen if you put $200 a month in an investment that yielded 10% a year for 30 years…you would have $412,587.
Your Relationship With Credit is A Reflection of Your Relationship With Money
How you feel about credit is a reflection of how you feel about money in general. Do you trust yourself with money? Do you trust yourself to be responsible with a credit card? It’s ok if the answer is no, but it’s worth looking at why and getting to the bottom of it. If you made mistakes in the past, let them go. I absolve you. Start from where you are and work towards something better.
If you’re into law of attraction, it’s pretty hard to be asking the universe for more money and but not trust yourself with money.
What’s the Solution?
It’s the same solution that works for living a great life. Everything in moderation, including chocolate and credit cards and techno music.
If your credit score is low, figure out why. If you have no credit, start with a credit card. It might have to be secured, but that’s ok.
If your credit history is less than stellar, start by repairing it, and then get a credit card. It still might have to be secured, but usually for just a year.
Try not to carry a balance, but if you do, keep it at less than 30% of your credit limit. 10% is ideal. And of course, make your payments on time.
Most scores in the 500s will jump 100 points if they open a new card, and even farther after they make consistent payments.