The Unforeseen Pitfalls of Credit in Retirement

The American College of Financial Services
March 26, 2020

Credit, from both a personal and a business perspective, is something many people take for granted in the modern day but which is important for daily living on a variety of levels. Governed by the debts you owe, your payment schedules, history and mixes of financial accounts, and other factors, good credit is what enables a person to buy a house, qualify for a loan, and put any number of potentially life-altering decisions into action. Bad credit can just as easily stop those things from happening.

From the standpoint of borrowing, young people are, by and large, much more likely to engage in the kinds of activities that would require a good credit score: taking out a student loan, or a mortgage for a house, etc. For those at or nearing retirement age, it’s likely they’re starting to think more about preserving and ensuring their current wealth income lasts than they are about borrowing more. It’s a sensible position, until this refocusing starts to cause people to neglect their credit scores. The truth is while credit may not seem like something the aging have to worry about, a poor credit rating can, and too often does, come back to bite retirees in the form of consequences they and their financial advisors have overlooked. As March is National Credit Education Month, we’re taking this time to remind advisors everywhere that in retirement planning, credit is still very relevant and should factor into any decisions you or your clients make.

The good news is that credit is unaffected by many of the traditional factors that might first come to mind: income, assets, employment status, or (in most cases) checking your score. In addition, personal age doesn’t count against an individual person’s credit score, and according to FICO (the creators of the credit scoring system), older Americans and retirees are much more likely than younger people to have good or excellent credit. It’s to be expected, since they’ve had a lifetime to pay off potential debts and get their financial houses in order.

However, this doesn’t mean credit becomes any less important in retirement, and advisors and clients need to stay vigilant. A host of issues facing retirees can be affected by credit scores, and some circumstances more prevalent among an older community can even conspire to deflate a high credit rating they’ve worked their entire lives to build.

A big drive many people feel in their retirement is to simplify their lives. Their kids have left home, they’re no longer working, and now it’s time to downsize. They trade in a big house for an apartment, or find other ways to live within their new means while maintaining a comfortable quality of life. Another part of this can be closing credit card accounts. After all, why leave the temptation to potentially overspend sitting there when you don’t need it? What isn’t often considered by advisors or clients is the fact that closing one credit account has the effect of decreasing a person’s overall debt-to-limit ratio and bringing the upper limit of their credit down, possibly lowering the threshold of how high they can go before maxing out their credit. Even if they don’t have many significant debts, credit scores can take a dive as a result. For retirees who can’t afford financial shocks the same way younger people can, it’s much better to leave those accounts open and unused than try to close them prematurely. In the same manner, trying to transfer all of a person’s credit to one account can put their usage much closer to the limit, even if they’re not really using that much credit.

Another part of this is closing out or paying off loans. It seems counter-intuitive, but having no loans can sometimes be worse than having one that’s in the process of being paid off. When credit agencies see someone who has outstanding debt, but is making regular installment payments on it, it’s a much more attractive proposition than someone with no debts at all. A savvy advisor will take this into account by counseling clients on not only paying off loans that still exist, but when and how is the proper time to do so. Finally, credit diversity is also key to a healthy credit rating. In the same way that having too few sources of credit can drive down your score, having too many that are the same kind--either revolving or installment--can hurt too. A strong credit score is best created through an appropriate mix of the different types of credit. Consult with your clients and learn their financial situation before deciding what the most appropriate plan will be.

When your clients retire, there’s certain to be a laundry list of things they want to be able to do, from traveling more to fixing up their home or even helping other members of their family do what they want to do. Perhaps your retiree clients are co-signers on the car loan of a younger family member. Perhaps they’re dying to take that trip to Hawaii they’ve always dreamed about. Or maybe they’re looking to redo their new, smaller house by using a home equity line of credit, or simply lower their insurance payments to ease financial burden. In any of these situations, credit still matters. When your clients’ credit score slips in retirement due to unpaid bills, poor financial choices, or any other possible factor, they suddenly may find themselves unable to qualify for that travel rewards credit card program they’ve been banking on, or facing higher premiums and lower borrowing limits. A co-signed loan is one of the biggest threats, because if the other signer defaults on their payments, creditors are free to come after both them and your retired clients for payment, and their credit score is now doubly at risk. Disentangling complex financial situations like this is just one step of a comprehensive retirement plan, and it’s critical advisors and clients have open and honest communications about status and security.

And for younger clients who are just starting to think about saving up and positioning themselves for a comfortable retirement, it’s critical to start having these conversations early and often, especially when it comes to credit. Looking at financial planning from a holistic approach is essential in navigating today’s turbulent and intricate landscape. Put a framework in place so clients can begin to pay down debts strategically, without hurting their credit score. Encourage them to put credit diversity at the forefront of their planning. Help them create alternative pathways to handle big expenditures and avoid putting all of it on their lines of credit. And above all, educate them on the importance of their personal credit scores and how it can, if properly managed, be a positive boon to their future retirement. It’s never too early to start thinking ahead.

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