Credit scores often get viewed as a stand-in for a person's entire financial life, when in fact they reflect only one element of that life -- how a person manages credit. Important elements of people's finances don't show up in their credit scores at all, including how much money they may have in savings.
What Credit Scores Count
Your credit score takes into account how you've used credit in the past and how you're using it now. That's it. According to the Fair Isaac Corp., which devised the FICO credit score formulas used by the major credit reporting bureaus, the score covers five areas. Your payment history -- whether you've been on time, how often you've been late, and whether you've defaulted -- makes up 35 percent of your score. The amounts you currently owe -- both in dollar terms and as a percentage of all available credit -- account for 30 percent. The length of your credit history counts for 15 percent. Newly issued credit makes up 10 percent, and the variety of credit -- the different types of accounts you have -- counts for 10 percent.
What Isn't In There
Some of the biggest things in a person's financial life don't appear in the credit score. Neither your credit score nor your credit report reveals whether you have a job. Your credit report doesn't say directly whether you own a home or a car, or whether you have a college education, although it does report whether you have had a mortgage, a car loan, or a student loan recently. It doesn't say anything about your assets -- such things as savings and checking accounts, stocks and bonds, or other investments. It only gauges your past performance with credit, not your future ability to make payments.
Low Savings Won't Hurt You
On the flip side of the discussion, the fact that a credit score doesn't consider bank accounts means that your score won't take a hit if you don't have any savings. Even if you wind up overdrawing your accounts and incurring fees from your bank, that usually won't show up on a credit score because there isn't a credit account involved. The bank is simply charging a fee to your account.
How Savings Can Help
If you have substantial savings and are looking for a way they can improve your credit score, then use some of those savings to pay off or pay down your outstanding credit balances. The size of those balances plays a big role in your score. Paying down outstanding balances also just makes financial sense. Imagine you have a $1,000 balance on a credit card that charges interest at 12 percent a year. That balance will cost you $120 a year in interest. A savings account will pay you, at best, a few percentage points in interest. If you have $1,000 dollars in a bank at 2 percent, it will earn just $20 a year in interest. Using savings to pay down the credit card saves you money and improves your credit score. Income that you had been diverting to credit card payments can then go back into savings, and you'll come out ahead.
- credit card image by jimcox40 from Fotolia.com