The impact of debt on credit scores: Smart Money, Longevity literacy

We answer real-world questions about money in the Smart Money Podcast from NerdWallet. This episode will help you improve your longevity literacy to ensure that you do not retire prematurely (or too late). You’ll also learn about how your debt can affect your credit score.

Sean Pyles & Liz Weston explore the important but often ignored concept of literacy in longevity. The two discuss the common misconceptions about life expectancy that can cause retirement planning mistakes. They also share a calculator to estimate your life expectancy.

The Money Question of the Day: Sean & Liz dispel common myths about credit scores, including that it is impossible to have a good score without debt.

The article explains how credit cards and other types of accounts can impact your credit score.

Listen to this podcast on any of your preferred podcast platforms, including:

Stories related to this episode.

Sean Pyles: Hey, Liz, I’ve got a weird question for you.

Liz Weston: OK.

Sean Pyles: Would you describe yourself as morbid? How much time do you spend thinking about your retirement?

Liz Weston (quoting Haruki Murakami): “Norwegian Wood”, the author’s book, says that death, not life, is an inherent part of it. It’s a part of planning for retirement, whether you like it or not. You need an idea of your retirement life expectancy to determine how much money you should save.

Sean Pyles : That’s a yes.

Liz Weston: Fine.

Sean Pyles, NerdWallet Smart Money Podcast: We answer your questions about money with our Nerds. Sean Pyles.

Liz Weston: And I’m Liz Weston.

What’s your biggest money problem? Send us your money questions, whether you want to purchase a new car or simply kick a bad habit.

Sean Pyles: If you want to leave a message or send us a text, please call the Nerd Hotline 901-730 6373. That’s 901-730-NERD. Email us by clicking [email protected]

Liz Weston (in this episode): Sean and I respond to a question from an audience member about the impact of debt on your credit score. We’ll first tell you why your life expectancy is likely to be longer than what you believe and how that will affect your finances.

Sean Pyles: I was inspired to start this conversation by Liz’s recent column. Hence my question. Many people find it difficult to imagine themselves as they age. However, imagining what the future will look like for you and how many years you have left can be helpful in planning.

Liz’s column, “You’ll probably live longer than you think,” asks, “If we are not going to die tomorrow, then what should the public know about life expectations?”

Liz Weston (in response to an email): First, it’s unlikely that you’ll die tomorrow, or any time soon, because the majority of people reach retirement age and, once there, are likely to continue to live for another 20 years. A growing number of people will live into their 90s.

A couple of 65-year-olds has a 50% probability that one member will be still alive when they reach 92. The Society of Actuaries crunches all of the data and numbers to determine the probability of events in the future.

Sean Pyles, your column discusses longevity literacy and illiteracy. This is a new term to me. What is it and why should people know?

Liz Weston: Yeah. You’ve probably heard about financial literacy. It is basically knowing how the money system works. Understanding longevity, or how people live longer is what longevity literacy means. This is important for retirement planning, because overestimating your lifespan could lead to you retiring too early or cutting back too much. If you underestimate it, then you may retire too early, overspend and be short on money.

Sean Pyles That’s not something that you want to be doing in the future.

Liz Weston, exactly. Many people start off well. After retirement, they believe they have it all under control. By the time people reach their 70s or 80s they are really in trouble.

Sean Pyles Okay, so you’re in retirement for 10, 15, 20 years, when you suddenly realize that you don’t have the money you expected.

Liz Weston: Exactly. This is what we call longevity risk. You’re more likely to exhaust your savings the longer you live and need to depend on Social Security.

Sean Pyles: You also wrote that longevity persists in your article, which I thought was a very good way of framing it. The idea is that statistically speaking, the more you live the longer your life will be.

Liz Weston: Exactly. It’s important to understand this because the majority of figures that we come across that are related to life expectancy, measure it starting at birth. In the United States, life expectancy averages 76. Once again, this is from the date of birth. This is a useless statistic when planning your retirement. The life expectancy includes infant mortality. If you are listening to the podcast, infant mortality is not included in life expectancy.

Sean Pyles, we may be listening to some young people. Who knows?

Liz Weston That’s right, but you are probably too young to be concerned about it.

The figure to be concerned with is the life expectancy of 60-65 years old. You are more likely to live longer if you’re more educated and earn more money. It’s worth using a calculator to get an estimate that takes into consideration your health, lifestyle and genetics.

I came across a website called Livingto100.com that had a number of questions, but it was worth the effort to focus on your personal life expectancy.

Sean Pyles : I am also morbid, so I did the survey before this recording.

Liz Weston What did it say,?

Sean Pyles : I was told that my life expectancy is estimated at 93 years old, not 100. I will try to change some things to reach that goal.

Liz Weston (in mid-50s): Right now, 1 out of 3 males and 1 out of 2 women in mid-50s expect to live well into their 90s. Life expectancy will continue to increase, they believe. There’s been a blip in life expectancy recently with opioid addictions and COVID. But, people of your age or younger have a good chance to live to 100. By the way, that is a very long retirement.

Sean Pyles: Yes, it is. You mentioned the longevity risk, which is the possibility that people may outlive their retirement savings. This is a scary thought, particularly for people who are older. What are some ways people can reduce that risk?

Liz Weston: The single best thing that you can do to increase your Social Security is delay it as much as possible. This will permanently boost your Social Security payment, which may be your only income if your savings are gone. It’s important that it be the largest possible. Social Security benefits are adjusted for inflation, which means that the larger the Social Security check is, the greater the inflation adjustment. All of this will help you in the future. Many people begin Social Security way too soon and end up in financial trouble. You should learn more about Social Security and delay it as much as possible.

Sean Pyles : It is important to remember that, in most cases, we’ll have Social Security when it comes.

Liz Weston: It’s something we have said before and will say again. The Social Security system can still pay 80% of the promised benefits even if Congress does not fix it. Speaking of financial literacy, 80% isn’t zero.

Sean Pyles: Yes. We can also badger elected officials to the point that they fix it and then we don’t need to depend on 80 %.

Liz Weston : I really count on it that no one will want to reduce Grandma’s benefits. If you cut Grandma’s benefits, she will get you. This alone will be enough to motivate politicians to get it done.

Sean Pyles: Let’s hope that is so. Liz, thank you for mentioning your column. Let’s move on to the money segment of this episode. The money question for this episode comes from an email sent by a listener, read out loud by Kaely.

Kaely: Hello, Nerds. What is the relationship between credit cards and your credit score when you have no debt? My credit score has dropped after I paid off my car loans, student loans and credit cards. My credit score has dropped since I am debt free. My credit rating will be affected if I only use cash envelopes to spend. Help!

Liz Weston: Sean and I tackle this question from the listener on our own in this episode. Sean has written a book on credit scores, while I have authored a book on credit and debt.

Sean Pyles: We’re eager to bust the myth that debt is necessary for good credit. It’s simply not true.

Liz Weston: Yes. What does our listener mean when she says her credit score has tanked? It may seem like an important thing to some people if their credit score dropped from 800s to high 700s. But it is not. If you want to borrow money, the rates are still good. You also get lower insurance costs and other benefits.

Sean Pyles: It could be very concerning if the credit score actually dropped from 700s and 800s down to 600s. Our listener’s scores would have dropped if they had not just paid off the credit cards, but also closed them. If your score drops dramatically, it could be a sign of identity theft or that an account has been sent to collection.

Liz Weston, well let’s begin with the basics. Credit scoring can seem a bit complicated. Credit scores consist of three-digit figures. These scores are derived from credit reports and indicate your risk of not paying what you owe. These were designed for lenders and not us. They’re complicated because they were designed for lenders.

There is no one single credit score. You have several, which change constantly based on changes in the data contained in your credit report. The majority of credit scores range from 300-850. You’re less likely to be viewed as a risky defaulter or someone who won’t pay their bills if your score is higher.

Sean Pyles says that your credit rating isn’t a true reflection of who you are. The score of a person can drop dramatically if they make payments “on time” for many years and then, if a financial crisis strikes and they are unable to pay their bills on time. It’s a shame, because you don’t have to be a bad guy. But there are still ways for you to improve your score.

Liz Weston: Yes.

Sean Pyles : To get the best scores, like the ones in the 800s you need both revolving and installment accounts. Like credit cards, revolving accounts allow you to borrow and repay money. Installment loans include mortgages and auto loans, which have fixed payments to allow you to pay the loan down over time.

You may not be the best credit risk, even if you have a credit score in the 700s, if you repay all of your installment loans. You’re likely to have the same chance of being approved for a fancy travel card if you have a credit score in the 780s.

Liz Weston, exactly. Your scores may drop after you have paid off your installment loan because you don’t have the mix of credit that is required by your score. Because the scoring formulas are working with less data, they will not give you your highest possible score. As Sean said earlier, they are not necessary.

Closing your last installment loan may not be a big deal, unless you have also shut down all of your credit cards. I am worried this is what has happened to the listener. Credit is necessary to create credit scores. Credit scoring formulas will not be able to calculate your credit score if you close or stop using the cards.

Sean Pyles: If you use your credit card responsibly, it’s possible to avoid this. Make regular charges to avoid the card being closed by the issuing company. This will probably only occur after at least a year, and possibly several years. My credit card hasn’t been used for half a century.

Liz Weston Wow!

Sean Pyles says it’s open. They sent me a letter about six months back, saying they planned to close it. It’s open because I only charged $1 to the card.

Another good credit usage practice is only using a small fraction of the available credit. It is best to use less than 30% of the credit available.

Paying off your credit card balances completely is also good practice. This can also help you to avoid credit card interest. You’ll have a good credit rating if you do this month after month.

Liz Weston: My mother was anti-debt. It was her who taught me that I should pay off my credit card debt in full each month, no matter what. So this is how I have always paid. I have been fortunate to enjoy a good cash flow for most of my career.

Some people worry that they cannot handle their credit cards, particularly if they have accumulated large debts. Sean, perhaps you could talk about how you manage your credit cards and your past experience of debt.

Sean Pyles: In my lifetime, I have had to pay credit card debt twice. First, I was in college. So I got a credit-card because I wanted to buy a new iPhone. The one I had mentioned before, but hadn’t used it much. I had a credit limit of $200, which was the price for iPhones at that time. It worked really well. I paid it back over a period of two years. It took me a couple of years to pay it off.

A few years after that, for an important move I made, I got a credit card with zero-interest promotional periods. This card had a high credit limit at the time. The rental car I used for my move, and some other items I wanted, such as new furniture, I put on the card. Then I charged some items that I did not really need like new shoes. Then I bought a Nintendo Switch. I thought, “Yeah I’ll pay it off in time !”

The 18 months I was paying no interest seemed to fly by. It was a good thing I didn’t pay any interest because I closed out the balance prior to that. But it did show me my tendency to put things on credit cards that I do not necessarily need. It was a bit scary to think that I might end up with credit card debt.

My credit card balances are now paid off weekly. I will even pay them daily, if necessary, if my goal is to reduce my expenditure. It’s fascinating to see how my credit score fluctuates from week-to-week as I change my usage.

Liz Weston : You can track your progress based on the balance you keep on these cards.

Sean Pyles: I bought a $600 flight recently. It was partly because I wanted to know what impact my usage would have on my credit score. The score dropped 5 points. Then I cleared the balance of my credit card, and my score returned to its previous level. It’s difficult to pin-point what is causing your credit score to go up or lower, but this seems to be a clear correlation.

Liz Weston: You might also want to mention that your most recent statement balance is usually the one that appears on your credit report and that’s used for your credit score. Sean, you should pay off your debts regularly to ensure that the amount reported by the credit bureaus will be as low as it can possibly be.

The credit bureaus or your score don’t really know whether you have paid off all of your debts. Carrying credit card debt is not beneficial. This is not good for your credit scores and certainly does not help you.

Sean Pyles: It’s amazing to me that so many people believe this. This shows that personal finance is awash with misinformation. It’s not true that people believe they need to be in debt and have good credit scores, particularly credit card debt. It’s important to dispel this myth, especially given the high cost of credit card debt. You can tell your friends, family and co-workers that you don’t need to be in credit card debt for a high credit rating.

Liz Weston says that the book I wrote about credit scores has been through five versions, but the chapter on credit score myths has not had to undergo any major revisions. They are very common, like the idea that debt is necessary to get good credit scores. These stay in place. Another myth is that checking one’s own credit score will lower it. This simply won’t happen. You’ll find a variety of these.

It’s important to find a credit scoring system that suits you. Credit scoring is a big part of our daily lives. Credit scores are important in many different situations. You might think that you will never borrow again after paying off huge amounts of debt. Credit information is used by most auto and homeowners insurers to set their premiums. It is crazy that your credit score can be more important than your driving history when you are looking for auto insurance. Credit and credit scores are used by landlords to determine who can rent an apartment. The information is used by cell phone companies to decide who receives the best offers and rates. Utilities will use your credit history to determine how much deposit you need to pay. The list goes on.

Sean Pyles: Another listener mentioned cash stuffing, also called the cash envelope technique. It was an older method of budgeting that involved using envelopes and paper money to write down each expense and the amount you planned to spend for it. When the envelope for groceries is empty, stop shopping.

Liz Weston says that you can do the exact same thing using budgeting software or a spreadsheet. It can be risky to try and pay with cash. It’s possible to lose or steal the cash, which can make it difficult to pay your bills.

Sean Pyles Even if you want to take the retro route, and use cash envelopes for your payments, you might consider setting up an automatic charge to pay a little amount on credit cards. This will allow you to continue using the card and avoid the issuer closing it down.

Liz Weston (yes): Because again, it hurts your score. This is something you don’t wish to occur.

Sean Pyles: I’d like to mention that our listener, who felt punished after doing all the right things, is not alone. It can be frustrating for people to make on-time auto loans, or pay them off, but then see their scores drop afterward. This is the unfortunate way credit score models are designed. In this case, we are a bit of a product.

It’s not you who will be affected by a drop in your credit score; that’s what other lenders are concerned about. Although it’s not pleasant to have to deal with a system we did not ask to join, the only thing we can do is to follow the rules and try to improve our score.

Liz Weston says that knowledge is power. You can improve your credit score by understanding the system better and knowing that it is designed for lenders, not us. If you know how to use the information and understand how it works, then you can save a lot of money.

Sean Pyles : This can help separate emotional impacts of credit scores dropping. It’s painful to realize that your score has dropped and you won’t be able to get that travel credit card you’ve been wanting. In the worst case scenario, you may not be able to get an apartment you want. You can improve your credit score. You can improve your score by using tools such as secured credit cards and credit builder loans.

That’s about it. Now let’s move on to our tips for taking away. Liz, would you like to start off?

Liz Weston: I’m delighted. You don’t have to be a debtor to get good credit scores. Credit cards can help you achieve good credit scores if they are paid off completely.

Sean Pyles: Closing accounts will hurt your credit scores. Close all your accounts and your scores will eventually be affected.

Liz Weston, a good score is important. Good credit scores are still important even if you don’t plan to borrow any money. They can save you money on your insurance, phone plans, and utility bills.

Sean Pyles: That’s all for this episode. Have you got a question about money? Call or text 901-730 6373 to ask the Nerds your money questions. That’s 901-730-NERD. Email us by clicking [email protected]

Visit nerdwallet.com/podcast for more info on this episode, and remember to follow, rate and review us wherever you’re getting this podcast.

Liz Weston, here’s a brief disclaimer. This is not a financial or investment advisory. The information provided is for entertainment and educational purposes only and does not necessarily apply to you. Sean Pyles produced this episode with myself. Kaely monahan mixed the audio and we’d like to thank NerdWallet for their assistance.