Every month, one of the credit cards I use shares an updated FICO credit score with me. With its February update, my score dropped a whopping 49 points. That move knocked me down to a lower rating classification in the credit rating system, making it appear as though I'm a bigger credit risk than I was before.
Yet the key reason my score dropped so much is that I paid off my mortgage. Indeed, the key negative driver affecting my score is described as follows: "There is either no recent activity or insufficient information about your installment loans. Having a loan along with other types of credit demonstrates that you are able to manage a variety of credit types."
Only in the squirrely world of algorithmically driven ratings does paying off a huge debt and freeing up nearly $1,800 per month in cash flow make someone a worse credit risk. Frankly, I'd rather have that much more cash in my pocket every month than the bragging rights of a higher credit score. That's why I'm OK with having my credit score drop nearly 50 points.
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Paying off debt vs. investing
Up until recently, I firmly believed I'd keep my mortgage -- which was at a 3.61% interest rate -- until it matured and to try to beat that rate over time by investing in stocks. Then, 2021 and 2022 happened, and that strategy became far less appealing. It wasn't because the stock market went down, but rather because inflation skyrocketed, and my net paycheck did not.
With prices rapidly rising -- food, energy, and car-related costs hit our household particularly hard -- and income not keeping pace, something had to give. The big elephant in the room was the mortgage. I believe that it's fine to have some debt while investing if all three of the following are true about that debt:
- It is at a low interest rate.
- Its payment is low enough to not hamper your core lifestyle.
- It is in service of a key priority for your future.
Thanks to our other costs that were rising so quickly, our mortgage stopped passing that second test. So despite the low interest rate and the fact that we have to live somewhere, it was no longer worth it to keep holding on to that mortgage.
Now that it's paid off, however, we can again comfortably cover our core expenses from salary and resume putting money aside for our future priorities. That's way more important than having the bragging rights that come with a higher credit score.
Treat credit as a tool, and it can serve you well
As imperfect as it may be, your credit score generally does a reasonable job of measuring the likelihood that you will be able to pay back money you are loaned. It says absolutely nothing about the rest of your financial picture, though. As a result, your goal should not be to try to get the highest possible score, but rather to use your credit as a tool in your overall financial plan.
If you need to borrow for a major life expense -- like a home or an education -- recognize the rules and trade-offs involved and strive to keep your payments current. In addition, recognize that these days, with interest rates on newly minted mortgages around 6.5%, it's tougher to justify holding on to a mortgage to invest than it was when rates were lower.
For your daily expenses, credit cards can be a useful tool to protect you from the risks of having cash stolen, and the rewards can be reasonable perks, as well. Just be sure to pay off the total balance every month to avoid paying interest rates, which these days are pushing 20%.
No matter what your current credit situation looks like, treating credit as a tool can be a key part of getting in control of your overall financial situation. Make today the day you start down the path, and improve your chances of reaching the point where you too can be OK with a nearly 50-point drop to your credit score.
