Credit Scores Don't Measure Your Financial Health - Here's Why

We all have been often charmed by the magical figure called the ‘credit score’. Even if we aren’t sure of why or how, a high credit score gets a solid nod of approval from us. And not just that, we feel great about our financial health because we have a high credit score.

Now, just to be clear, it isn’t unnatural to feel good about having a good credit score. A credit score is a measure of your ability to return any loan or credit. So a good credit score can help you get more loans, more credit cards, increased credit limit etc. But all these are just an aspect of your spending and repaying capabilities, not your entire financial health.

So, the fact is that your credit score is not a measure of your overall financial wellness. Let’s try to understand it.

What Your Credit Score Measures

A credit score is intended to measure your credit-worthiness. It is a three-digit number ranging between 300-900, 900 being the highest. Which means something between 700-900 is a very good credit score.

It takes into account multiple factors such as your payment history, credit utilization ratio, credit history, credit mix etc. to calculate your credit score.

So, in a way, it is measuring your ability to spend and we all know that spending is just one aspect of your financial wellness. The other aspects of your financial health include saving, investing, retirement planning, financial literacy and more. So having a good credit score doesn’t necessarily mean that you are doing great in all the other areas of your financial life.

Elements of Your Overall Financial Wellness

Financial wellness is a state in which you are in complete control of your finances and have a financial plan that assures you of financial security in the foreseeable future. The two main components of financial wellness are:

Financial Security: A  state where you have a stable source of income, and you can maintain your desired lifestyle while still being able to save some money for the future. Being debt-free or having a clear time-bound plan to become debt free are crucial components of financial security.

Financial Independence: This is a state in which your interest in income/passive income exceeds your lifestyle expenses. This gives you complete freedom to pursue whatever goal you wish to follow in your life without having any financial worries.

So a good measure of your overall financial wellness would be to ask yourself some simple but important questions, like:

  • Are you saving for your short-term and long-term financial goals?
  • Do you have an emergency fund?
  • Are you following a monthly budget?
  • Have you cleared all your debt?
  • Have you insured yourself and your family for unforeseen events?

                                 Know Your Financial Wellness Score on Wizely

Good Credit Score and Bad Financial Health

So looking at your financial wellness from the lens of your credit score will not only be misleading but will also lead you to make poor financial decisions. You could have an excellent credit score while still performing poorly in other aspects of your financial life. Here are some reasons why:

  1. Your credit score doesn’t give any indication of your spending habits. Are you overspending or spending just enough? You could be living from paycheck to paycheck and yet maintain an excellent credit score.
  2. Your credit score doesn’t take into account your assets. You might own no assets at all and still have a high credit score.
  3. The biggest factor - your credit score doesn’t measure your savings. You could be saving almost nothing with no retirement planning and still qualify for a high credit score.
  4. And finally, what about emergency funds and insurance cover? Your credit score doesn’t measure if you are protected financially, if you have the adequate insurance or not.

Bottomline: Your credit score is a partial representation of your financial wellness. You should be smart enough to know when to chase a good score and when to work on the other aspects of your financial wellness. Taking financial decisions based solely on your credit score might harm you in the long run and it might be too late then to recover from them.

Follow our 'Financial Score vs Credit Score' Blog Series:
Credit Score vs Financial Score - How Are They Calculated?
Why Wizely's Financial Wellness Score is Important For You

Asha Ritu

Asha Ritu