37

I notice people talk about credit scores for many things, but typically they are:

  1. Helping tools for mortgages;
  2. Ability to get better loans;
  3. Ability to get better financing options.
  4. The general reasons that apply to anyone (i.e., borrow money, get rewards, payback, etc.)

My questions are simple and mean no offense:

If you are well-off financially there's a good chance you may omit one or more of these options. For example, someone well-off can afford to simply buy a house and credit wouldn't matter specifically for this anyways. Financing vehicles may be something a person of any income or net worth could do, but if you're well-off, I don't see why this person wouldn't buy at some point even if they lease and credit can get better deals. It just seems that these tools associated with credit seem more marketed to people with lower-incomes because financing is a way of paying longer-term, which people of lower incomes may be more forced to do since they may have not enough income or overall net worth.

Also, they are probably less likely to get loans if they have a good handle on money.

By "well-off" I clearly don't mean rich (as in multi-millionaire or up) - I just mean someone who can afford a house/car/etc. without having to forcibly do so through long-term payments.

I'm not saying credit isn't used when you have high income, but these specifics associated with credit that are boasted about much are way less considered when you have higher net worth - hence, credit cards still have good use for any income bracket, but other things are not so much.

My dad, for example, bought the house I grew up in all straight - no mortgage/etc. He had to work years and years to comfortably do this, but nevertheless his credit didn't matter for this.

  • 20
    I think if you're well-off, and reasonably sensible about money, you get a good credit score whether you want it or not :-) A mortgage is the only loan I've had since I paid off my student loans a couple of decades ago, I use credit cards for convenience (and the rewards & 0% interest - free money's always nice :-)) and always pay the balance in full, and yet somehow I wind up with an 800+ credit score. – jamesqf Nov 19 '16 at 4:31
  • 3
    I'm retired, saved a lot, and have no need to use credit, So I didn't and that turned out to be a big mistake because if you never use credit - which is not the same as having debt - you will have a blank credit report no matter how much you have in the bank. And this can have adverse consequences in several ways from getting cell phone service to renting apartments to booking hotel rooms. Been there done that. – doug Nov 19 '16 at 7:02
  • 15
    If you measure being well-off by being able to buy a house outright then there would be many places where almost no one who owns a house is well-off! For example, consider Sydney, where median incomes are $67,600 and median house prices are $1,068,303. – curiousdannii Nov 19 '16 at 12:00
  • 7
    At the very least are you sure you will be well off forever? God forbid, but maybe tomorrow there will be some emergency that will heavily strain you financially. When you come out the other side of it (or perhaps even going through it) a good credit score is useful – David says Reinstate Monica Nov 20 '16 at 3:40
  • 8
    The paradox of credit score: The more likely you are to need credit, the less likely you are to get it. – Philipp Nov 21 '16 at 12:04
38

Your dad may have paid an "opportunity cost" for that outright purchase. If the money he saved had been invested elsewhere, he may have made more money. If he was that well off, then his interest rate should have been the lowest possible. My own father is a multi-millionaire (not myself) and he could afford to have paid for his house outright. He didn't though. To do so would have meant cashing in on several investments. I don't know his interest rate but let's say it was 2.5%. If he invests that million dollars into something he expects to get a 7% return on in the same period, then he would make more money by borrowing the money. Hence, he would be paying an opportunity cost.

Assuming you need to work, some jobs will also do background or credit checks. Credit cards can be used by well off people to actually make them money by offering rewards (compared to straight cash transactions). The better your credit history, the better the cards/rewards you can get. You can build that credit history better by having these loans and making timely payments.

  • 5
    This is true from the perspective of many "well off" people I know. Also, their tastes are more expensive - fast cars and expensive houses - which doesn't help either. – Coomie Nov 21 '16 at 3:05
  • 15
    @Coomie: Not universally true. There are a good many people (I'm one) who are well off precisely because we don't have expensive tastes, and so have invested the money we otherwise would have spent on indulging them :-) – jamesqf Nov 21 '16 at 5:19
  • 3
    @Coomie I can tell that you have never read The Millionaire Next Door. – a CVn Nov 21 '16 at 14:54
  • 3
    @JimmyJames I don't think it's morality - I think that most people consider a house as unlikely or impossible to decrease in value. – stannius Nov 21 '16 at 15:58
  • 1
    @stannius I would have agreed with that prior to 2008 but in 2016? I'd hate to think that 'most' people have that short of a memory. From a lot of the blah blah blah on this site, it seems like a lot of people are actually irrationally worried about that happening now. I don't even mean a huge housing bubble type problem. I recently read about a guy who discovered his driveway is paved with radioactive waste. He'd be better off letting the bank deal with it. – JimmyJames Nov 21 '16 at 16:24
28

Credit scores, or at least components of them, can sometimes factor into how much you pay for car insurance.

Source: Consumer Reports: How a Credit Score Increases your Premium

  • 5
    This is true in most states. I'm lucky (because I used to have zero credit) to be in Calif. where insurance companies are not allowed to use credit reports for auto insurance. – doug Nov 19 '16 at 6:05
  • 1
    At this level of wealth, self-insurance can be an option. – MSalters Nov 21 '16 at 10:12
  • 2
    @MSalters some jurisdictions (such as Great Britain) do not allow self-insurance for cars – Qsigma Nov 21 '16 at 11:49
  • @Qsigma: Does the UK have universal credit scores? The question only makes sense in a few jurisdictions anyway. – MSalters Nov 21 '16 at 12:55
  • Many US states have mandatory insurance, however the required amount is usually fairly minimal, so paying more for it shouldn't hurt the hypothetical rich person. – stannius Nov 21 '16 at 15:59
26

Because even if you won the lottery, without at least some credit history you will have trouble renting cars and hotel rooms.

I learned about the importance, and limitations of credit history when, in the 90's, I switched from using credit cards to doing everything with a debit card and checks purely for convenience. Eventually, my unused credit cards were not renewed. At that point in my life I had saved a lot and had high liquidity. I even bought new autos every 5 years with cash.

Then, last decade, I found it increasingly hard to rent cars and sometimes even a hotel rooms with a debit card even though I would say they could precharge whatever they thought necessary to cover any expenses I might run.

I started investigating why and found out that hotels and car rentals saw having a credit card as a proxy for low risk that you would damage the car or hotel room and not pay.

So then I researched credit cards, credit reports, and how they worked. They have nothing about any savings, investments, or bank accounts you have. I had no idea this was the case. And, since I hadn't had cards or bought anything on credit in over 10 years there were no records in my credit files. Old, closed accounts had fallen off after 10 years.

So, I opened a couple of secured credit cards with the highest security deposit allowed. They unsecured after a year or so. Then, I added several rewards cards. I use them instead of a debit card and always pay in full and they provide some cash back so I save money compared to just using a debit card. After 4 years my credit score has gone to 800+ even though I have never carried any debt and use the cards as if they were debit cards. I was very foolish to have stopped using credit cards 20 years ago but just had no idea of the importance of an established credit history. And note that establishing a great credit history does not require that you borrow money or take out loans for anything. just get credit cards and pay them in full each month.

  • 2
    This is arguing for a credit card, not a credit score. For the well-off who are the subject of this question, a good credit score is just a side effect of using a credit card. – MSalters Nov 21 '16 at 10:08
  • 4
    MSalters I don't understand your comment. If your credit card provider uses credit scoring (as I think most do), you need a good score to get a mainstream card with no fees. – Qsigma Nov 21 '16 at 11:55
  • 3
    Credit cards are the largest, positive factor in a credit score and, unlike other reported debts like auto loans or mortgages, they can have zero cost and even save money. If you only get a credit card, pay it on time, and have no negatives in your credit file, you will have good credit. – doug Nov 21 '16 at 18:06
  • The rental cars & hotel rooms argument is irrelevant if your lifestyle is such that you don't rent cars or stay in hotels. OTOH, having a credit card makes it a good bit easier to buy stuff & pay bills online. – jamesqf Nov 21 '16 at 18:08
  • "Because even if you won the lottery, without at least some credit history you will have trouble renting cars and hotel rooms." I would rather say payment history since even with credit cards you can operate them in a way that you never take any credit. And if you won the lottery, you will automatically get a good payment history. What you argue for is more the necessity of having a credit card. It also depends on the location. I live in Europe, and can rent cars or pay for hotel rooms well even before I had a credit card (now I have one, but I never use the credit). – Trilarion Nov 22 '16 at 15:18
21

A $250K earner might have $4M in retirement savings and $500K in available funds, but doesn't wish to spend all his liquidity on the house. In general, a house might cost 2-3 times one's annual income. It would take many years to get that saved up. They might want to have the house sooner.

It all goes back to choice, priorities, personal preference.

  • 1
    That's a good point. A mortgage is hard to get if you have not established a credit history. Too many avoid credit cards because they see them in a negative light and associate them with debt which they eschew. But credit cards can be used like debit cards where you pay in full. Not only are they cost free but you can get rewards and cash back as well. Doing so for just 3 or 4 years will make it easy to get a mortgage at the best rates and save tens of thousands of dollars. – doug Nov 21 '16 at 5:23
  • $4M in retirement savings and still having a mortgage? I understand not sacrificing liquidity, but those retirement savings need not be liquid. Also, a paid-off house effectively is part of a retirement package. – MSalters Nov 21 '16 at 10:03
  • @MSalters - This year, that $250K earner (or any couple with access to a 401(k)) can put aside $36K into their retirement account. Add $11K into their IRAs. It's very possible that an older couple has exactly this mix, very heavily skewed toward their retirement accounts. – JTP - Apologise to Monica Nov 21 '16 at 10:33
  • @JoeTaxpayer, the advice is that you should not buy a house that costs more than three times your annual income. Somehow, that's gotten reversed into being a minimum rather than a limit. – Mark Nov 21 '16 at 22:09
  • 1
    @Mark: That's basically saying the house price should be around 300% annual income. But that's not a direct concern; the portion of your income spent on housing is. There are two major drivers for house prices, interest and the wish to pay off the mortgage during your career. At the current rates, the latter term has come to dominate the equation. For instance, I expect to soon pay <1% interest, which leaves about 3% repayment. That means the 3X house price comes in at only 12% of my annual income, instead of the 30% which was common when interest was ~7%. 4X-5X today is still comparable. – MSalters Nov 22 '16 at 0:04
7

People just love becoming more well-off than they currently are, and one of the ways they do it is with leverage. Leverage requires credit. That desire is not exclusive to people who are not already well-off.

For a well-off person who wants to become more well-off by expanding their real estate ventures, paying cash for property is a terrible way to go about it. The same goes for other types of business or market investment. Credit benefits the well-off even more greatly than it benefits the poor or the middle-class.

  • Why is paying cash a terrible way to go about investing in real estate and business? – user9760 Nov 21 '16 at 18:37
  • "Credit benefits the well-off even more greatly than it benefits the poor or the middle-class." Really? So they lend each other the money (after all it has to come from somewhere) and magically that makes them better off? Leverage surely goes in both directions. – Trilarion Nov 22 '16 at 15:20
  • @Trilarion actually the money doesn't have to come from anywhere. A bank can take, say, $10k in deposits and use that as the reserve to make a $100k loan. $90k just got created out of thin air. Here's a half-decent explanation: cnbc.com/id/100497710 – stannius Nov 22 '16 at 17:04
  • Because, @tubes, with credit they can do ten times as much business as they can with cash. In other words, ten times the profit potential. Did you read the link to the WP article on leverage? – Beanluc Nov 22 '16 at 20:45
  • @stannius Okay, but still leverage still goes both ways. I just doubt, leverage beyond a certain level is actually making anyone more well-off. It just fuels a credit bubble which bursts at some point and in the end you might even lose money overall. As a defensive stance in certain situations it might make sense to buy some property paying cash for those who love not to be less well-off. – Trilarion Nov 23 '16 at 7:53
4

Credit in general having no significant change between an income level or net worth is due to the economic reciprocity principle inherent in many societies. Although some areas of credit may be more admirable to those who aren't as well-off, such as car loans, the overall understanding of credit is a trust agreement between someone getting something (e.g., credit card user) and someone giving something (e.g., bank or company). Credit doesn't have to mean just money -- it can be anything of value, including tangible materials, services, etc. The fact is that a credit is a common element in most economical systems, and as such its use is not really variable between income levels/etc.

Sure, there is variance in things like credit line amounts and rewards, but the overall gist is the same for everyone -- borrowing, paying back, benefits, etc. All of these exchanges form the same understanding we all know and follow. Credit brings along with it trust -- the form represented in a score. While not everyone may depend entirely on credit, and no one should use credit as a means of getting by entirely (money), everyone can understand and reap the benefits of a system whether they make 10K a year of 10M a year. This is the general idea behind credit in the broadest sense possible.

Besides, just because one has or makes more money doesn't mean they don't prefer to get good deals. Nobody should like being taken advantage of, and if credit can help, anyone can establish trust.

  • Trust is maybe more closely related to the payment/transaction history (e.g. how timely one pays for his bills). It doesn't have to be credit necessarily. Even if you never took any credit in your life I think your actions can still tell me if I should trust you or not. – Trilarion Nov 22 '16 at 15:23
3

I have never had a credit card and have been able to function perfectly well without one for 30 years. I borrowed money twice, once for a school loan that was countersigned, and once for my mortgage. In both cases my application was accepted.

You only need to have "good credit" if you want to borrow money.

Credit scores are usually only relevant for people with irregular income or a past history of delinquency. Assuming the debtor has no history of delinquency, the only thing the bank really cares about is the income level of the applicant.

In the old days it could be difficult to rent a car without a credit car and this was the only major problem for me before about 2010. Usually I would have to make a cash deposit of $400 or something like that before a rental agency would rent me a car. This is no longer a problem and I never get asked for a deposit anymore to rent cars.

Other than car rentals, I never had a problem not having a credit card.

  • 1
    As someone who has never borrowed money (in the official sense -- technically, parents have (rarely) loaned me <$20 for a day or so in the past), I can confirm that I have had no trouble because of a low (or lack thereof) credit score. When you don't borrow money, it just rarely comes up. And that includes renting and going to college. (I will graduate debt free this year with a Bachelors.) – Azendale Nov 22 '16 at 0:12
2

there are several reasons you might want good credit even if you could afford to pay for all your expenses in cash.

  1. leverage: even if you have enough cash to buy a house, you might want to invest that cash instead. assuming your investments earn more than your mortgage interest, you come out ahead. mortgage interest is generally much lower than other margin interst. credit card interest can be zero for people with good credit.
  2. tax breaks: mortgage interest is tax deductible. also, investing inside retirement accounts can provide tax breaks. however retirement funds are not always available for other large purchase (e.g. house, car, yacht)
  3. rental and insurance rates: having good credit can get you better rates on things like car insurance and life insurance, etc. also, rental companies of all sorts, from cars and hotels to construction equipment will give you better and more convenient rental terms if you have good credit.
  4. promotional offers. there are a lot of promotional offers available in the credit space. notably, sign-up bonuses and/or cash back offers for credit cards can pay you hundreds of dollars per year if you have good credit.
  5. liquidity: you may not have the funds you need on hand for various purchases (e.g. house). tax rules (regarding retirement accounts, long term capital gains, wash sales, etc.) can all limit the availability of your funds. there are also some illiquid investments. for example, you may have real estate or collectibles that are difficult to sell for a good price on short notice.
  6. liability: during the recent real estate crash, many home owners chose to allow the bank to foreclose because it was cheaper than selling the house and taking a loss. especially in states that protect borrowers from liability, mortgage default can be a very profitable option. if you are considering liquidating retirement assets to buy a house, this is particularly interesting since retirement accounts have some protections from bankruptcy (although, your primary residence has other protections too).
  7. employment opportunities: employers are allowed to make hiring decisions based on credit scores in some states. also, federal security clearance requires a background check that includes a credit check. it seems unlikely that a few missed payments would make the difference in getting a job, but it is potentially a factor especially in the financial sector.

having pointed out all the above reasons to have good credit, it is probably worth noting that many people with good credit choose to not borrow simply because they are more comfortable with the risks of not borrowing (e.g. inflation risk), than they are with the risks of borrowing (e.g. investment volatility).

  • Very good answer although there are also quite some reasons one might not want to take any credit most prominent being maybe potential losses in case the investments earnings are less than the mortgage interest on average. – Trilarion Nov 22 '16 at 15:28
  • @Trilarion that is worth noting. i have updated my answer with a footnote accordingly. – james turner Nov 22 '16 at 15:59
1

Credit is very important even if you are wealthy.

One thing you may not realize is that rich people typically have comparatively little cash on hand. If they're smart, most of their assets are not liquid - they're tied up in safe, long-term investments. They use credit for their day-to-day expenses and pay it off from the dividends on their investments (which might only come in once a quarter).

There are also tax advantages to using credit. If a rich person wanted a new car, he'd be smarter leasing it for his business (immediate write-off of the lease payments on taxes) versus buying it (depreciation over several years plus property tax liability in some states). There are more elaborate tax dodges but the point is that buying a car outright is the worst option in terms of tax avoidance.

Another way the rich (mis) use credit is so that they don't risk their own money on business ventures. Let's say I have $1,000,000 in my personal bank account, and I want to buy a business that costs $1M. If I am dumb, I clean out my bank account and put all my money in the business. I get 100% of the profits, but I also bear 100% of the risk. If I'm smart, I loan 200K of my own money in the business and put the rest someplace safe, and get a loan from a bank for the other 800K. If the business succeeds, the bank gets their money back plus interest. If it fails, the business declares bankruptcy and the bank eats the 800k loss. If I structured the debt right, my personal loan to the failed business gets paid back first when the company is liquidated, and the bank gets whatever is left over (if anything). The most of my own money I can possibly lose is 200k, and probably it's closer to zero if I have a good accountant.

  • "If I structured the debt right, my personal loan to the failed business gets paid back first when the company is liquidated, and the bank gets whatever is left over (if anything)." - Do banks really agree to such terms? I guess the idea is nice, but in practice this hardly happens. – Trilarion Nov 22 '16 at 15:31
  • 1
    @Trilarion No, no sane bank would provide an unsecured loan for a personal business venture. – Sneftel Nov 22 '16 at 15:38

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy