It’s common knowledge that retiring early takes dedication and a strong financial plan. But people often overlook the importance of a good credit score for securing an early retirement.
The emphasis on planning for retirement has grown since the onset of the pandemic. In the past year alone, two-thirds of those in the millennial and Gen X age groups have begun planning for their long-term goals. Meanwhile, 50% of adults over 55 in the U.S. have stepped away from the job market for good, a two-percentage-point increase when compared to before the pandemic. This is also counter to long-term trends as the 55-plus group was the only working-age population to increase labor force participation since 2000.
For those with growing net worth, having early retirement goals can both lead to expanding wealth and strong savings rates. But one area you should keep an eye on is your credit score. No matter what you want to do in early retirement—whether it’s traveling, starting a dream business, or focusing on overlooked hobbies—the ability to borrow cheaply will keep your costs lower and provide a security blanket if things go awry. Having a good score can help you access cheap loans and other important tools to help secure your retirement fun.
Planning for retirement: Why your credit score matters
The pandemic changed a lot of plans for many people, and it also impacted the amount of debt that many held. Now, one in four say that paying off debt has become their number one financial priority, more than any other goal. It’s with good reason—paying off your debt will improve your credit score, which will also provide you with ways to develop strategies for protecting your wealth.
Maintaining a good credit score will give you more options for reaching your financial goals. Say, in retirement, you decide you want to move to a new home. With an excellent credit score, you can obtain a mortgage at better rates, protecting your costs for years to come. Or, say, an unexpected need arises for a child. You can find a loan—either by refinancing your home or through another source—at a lower rate since you have a history of paying your debts. Again, this ensures your retirement isn’t derailed by the unexpected.
But it also allows you to address your retirement comfort as well. If you want to renovate your home, you’re able to find a low-priced loan, even without traditional income.
The interest rate you pay on a loan will depend on your score, which ranges from 300 to 850. A score of over 720 is generally considered excellent, while those ranging from 690 to 719 are considered good. When you pay your bills, how much you owe, along with your credit age (i.e., how long you’ve had a credit history), the types of loans you have outstanding, and how recently you sought new loans play a large role in raising or lowering your score.
How to get your credit retirement ready
Reducing the amount of outstanding debt can improve your credit score. The more loans you have outstanding, the lower your credit score. Further, the higher the interest rates on those outstanding loans, the more you’ll owe, which results in another downgrade to your score.
The good news? Paying the loans back will increase your score by both reducing your debt and building your history of paying back loans on time. (Plus, it will increase your net worth in the process.)
While there are multiple ways to address high debt loans, one tactic is paying back the highest interest loan first. Pay the minimums on all your loans, but commit any extra funds you have at the end of the month towards the highest-interest loan. When that amount has been paid off, you can then move the funds you were paying towards the high-interest loan to the next-highest-interest-rate loan. This has a so-called “avalanche” effect, that can reduce the amount of interest you pay on all the loans.
In terms of your mortgage, paying back the loan will depend on your needs for income in retirement, the size of your costs, and the interest rate. If you only have the mortgage, it won’t likely cause a significant downgrade to your credit score (if you’re paying it back on time). And, if you have a low interest rate on the mortgage, it may prove beneficial to use funds elsewhere to further bolster your savings.
This will depend on the person, though. You can work with a financial advisor or a roboadvisor to weigh paying off the home loan early by determining how much of a mortgage you want to hold and how much you need to save in your investment portfolio by the time you retire.
Ways to maintain a good credit score throughout retirement
Maintaining a strong savings record is another way to improve your credit score. Planning for expected expenses in retirement will aid your ability to address concerns without having to open high-priced loans in a pinch.
A good example of this is in health care. Your health care costs will account for a significant percentage of your retirement expenses, if you have a retirement that’s consistent with the average American. One way to address this cost? By setting aside money in a health savings account (HSA). If you have a high-deductible health insurance plan while you’re working, then you can open and fund an HSA. This money isn’t taxed when you contribute, it grows tax free, and it’s not taxed if you use it for qualified health care expenses. This gives it a triple tax advantage, offering a powerful tool to save for a high expected cost, whether you’re retiring early or not.
Make sure to monitor your credit score regularly. The credit score is based on your credit report. Everyone is entitled to one free credit report per year from each provider, which can be accessed at annualcreditreport.com.
By seeing what’s impacting your score, you and your advisor can address all the concerns, giving you a clear pathway for your early retirement plans.
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