Personal finance guru Dave Ramsey has long had a cult-like following, and it’s easy to see why. Through his website, radio show, and Financial Peace University program, he preaches an array of strategies that improve lives and help people build wealth.
Pay off your debt and avoid future debt like the plague, he says. He also suggests you pay cash for everything and save a large percentage of your income. Meanwhile, Ramsey stresses the importance of avoiding the trappings of consumerism and forging your own path.
With advice like this on the table, what’s not to like? I mean, if most people followed Ramsey’s advice, they would be a lot better off – at least in a financial sense.
Five Ways Dave Ramsey Is Wrong About Credit and Credit Cards
But, when it comes to Ramsey’s advice on credit and credit cards, that’s where things start to get wacky. Not only is some of his advice less than optimal, much of it is too simplistic and not that feasible for people living in the real world.
Avoiding debt is always good — I’m a big advocate of living a debt-free lifestyle. But never using any credit is a recipe for disaster. Here are five sayings Ramsey repeats about credit all the time — and why I think he’s wrong.
‘You don’t really need a credit score.’
If you read Ramsey’s words or listen to his radio show, you’ll notice his disdain for the FICO score is palpable. This score is not much more than an “I love debt score,” he says repeatedly. And in some ways, he’s right.
Because of the way your FICO score is determined, you can be rewarded for carrying some debt. As Ramsey notes in a blog post, 35% of your FICO credit score is determined by your payment history (late or missed payments drag it down) while another 30% is based on your credit utilization ratio, or how much of your available credit you’ve used up. That means someone with a $300 balance on a card with a $500 credit limit will fare worse than someone carrying a $2,000 balance on a card with a $10,000 limit. These factors also don’t take your savings or net worth into account – just how you handle your debts.
I get all that, but then Ramsey goes off the rails. Basically, he says that, if you follow his plan, you’ll eventually pay off all your debt. Your credit cards, your car loans, and even your mortgage will be gone. At that point, your credit score will be “indeterminable,” he says.
Ramsey says this is good news because, if you’re doing it right, you’ll never borrow money again anyway. “By this point in your life, you haven’t taken out a loan in years, you’ve saved a ton of money, and you’re paying cash for everything,” he writes on his website. “So you don’t need a credit score, anyway, since you don’t plan on using credit!”
Sorry, but no. No matter what Ramsey says, you absolutely do need a credit score. Ramsey suggests renting a home until you can pay for a home in cash or at least put down 20%, but he fails to mention you will likely need a credit score to rent an apartment. And let’s not forget that your credit score may come into play when you apply for a job or sign up for auto insurance.
Not only can your employer ask for a modified version of your credit score before they hire you, but auto insurance companies look at your credit profile to determine how risky you are. If you don’t have any sort of credit history left, you may not get approved for a rental or be forced to pay higher insurance rates. And these are just a few examples of the many, many times having a good credit score works to your advantage.
- Related: Five Perks of Having Good Credit
‘It’s feasible to buy a home without a credit score.’
In an ideal world, people would save up 20% of the price of their home before they purchased. They would buy only as much house as they could afford, and they would get a fixed-rate mortgage with predictable payments they could swing no matter what.
In Ramsey’s world, they may even save up the total amount for their home in cash, and then pay for their property in one fell swoop.
Without a credit score, however – and a pretty good one, at that – you will have trouble getting a mortgage. Ramsey, realizing this, suggests that you can still get a mortgage without a credit score via manual underwriting.
With manual underwriting, Ramsey says you’ll need to be able to display 12 to 24 months of bills and payment history using rent stubs, utility bills, daycare payments, insurance payments, and any other bills you have. You also generally need to save up at least a 20% down payment to get a mortgage with this strategy, he says.
Unfortunately, his strategy may only work with people with no credit score. If you have a low credit score, you probably won’t qualify for a mortgage with any lender via manual underwriting.
While it may be possible to get a mortgage via manual underwriting without a credit score, this is a much tougher hill to climb. Not only do you need to save up 20% of your home purchase, but you need to find a lender willing to jump through all those additional hoops. In a hot housing market, you could also easily lose the home you want if you don’t get preapproved.
In the real world, it may make more sense to get a low-cost, fixed-rate mortgage with a traditional lender. If you have a low credit score, you can also get an FHA loan with a low down payment, low closing costs, and easy credit qualifying.
‘You will spend more if you use credit cards.’
According to Ramsey, nobody in the world has the discipline to use credit cards like cash. “You will spend more if you use credit cards. When you pay cash, you can feel the money leaving your hand,” he writes. “This is not true with credit cards. Flipping a credit card up on a counter does nothing to you emotionally.”
Ramsey waxes poetic about the fact “there is no such thing as responsible credit use.” The thing is, he can’t possibly speak for everyone.
Studies have shown we do spend more freely with plastic than cash. But like it or not, there are plenty of people who use credit responsibly, and to their advantage. Despite the high levels of credit card debt Americans accumulate each year, millions of them use credit wisely while paying their bill on time and in full every month.
Ramsey may be right that certain personalities – and a good share of American consumers – struggle with the responsibility of credit cards. But not everyone needs to stay away from credit cards altogether.
‘Credit card rewards are never worth pursuing.’
Part of Ramsey’s gripe with credit cards is the idea of people pursuing rewards. You have to spend thousands of dollars to earn a meaningful amount of cash back, he says. And if your credit card charges an annual fee, then chances are good you’re paying a ton in fees to score “free travel.”
While there are definitely instances where Ramsey is right, it’s also very possible to earn rewards and use them to your advantage. If you get a no-fee, cash-back credit card, only use it for regular purchases you’d make anyway (like gas and groceries), and faithfully pay your balance in full, for example, it’s hard to argue that you’re worse off getting a free 1% to 2% back in cash rewards on those purchases.
Admittedly, an annual fee makes it somewhat harder to come out ahead. But premier travel cards that charge annual fees also tend to offer juicier rewards. So if you travel a ton, and often take advantage of the card’s benefits, it can make sense to pay an annual fee.
The bottom line: Only you can decide whether travel rewards or cash-back cards leave you better off – or if you should skip them altogether. Ramsey can’t decide whether your efforts are worth it.
‘Debit cards are just as safe as credit for online purchases.’
While we’ve already shown how Ramsey’s credit advice may be less than stellar, there is one situation where he is absolutely, unequivocally wrong. He says that debit cards are just as safe to use as credit online, and this is false.
From his website:
You’ve told yourself paying with a credit card online is safer, so that’s a “good enough” reason to keep the card. But did you know a debit card offers the exact same fraud protection as a credit card? There’s really no excuse not to use it. Just remember to always check your budget first, and before you make a big purchase, sleep on it. Things have a funny way of looking less tempting in the morning.
Let me be clear: Debit cards do not offer the same fraud protection as credit cards, and it’s not even close.
A very cursory look at the Federal Trade Commission (FTC) website will show that you credit is safer than debit.
Here’s what the FTC has to say about credit cards:
Under the FCBA, your liability for unauthorized use of your credit card tops out at $50. However, if you report the loss before your credit card is used, the FCBA says you are not responsible for any charges you didn’t authorize. If your credit card number is stolen, but not the card, you are not liable for unauthorized use.
Debit cards, on the other hand, come with a lot more risk. Sure, you’re not liable for any unauthorized charges if you report your debit card stolen before someone uses it. But, it’s all downhill from there.
If you report your card lost or stolen within two business days of learning of the theft, you can be on the hook for $50. If you report the loss within 60 calendar days after your statement is sent to you, you’re on the hook for up to $500 in fraudulent charges.
If you don’t report the fraud within 60 days of your statement being sent to you, you could be on the hook for all fraudulent charges, including any money the thief can drain from your bank accounts.
The Bottom Line
While Dave Ramsey’s advice on debt-free living is superb, it might be wise to take his credit advice with a grain of salt. Life without any type of credit score won’t be as easy as he likes to portray on his website and radio show, and there are plenty of instances where you do need a credit score, whether he likes it or not.
The best way to approach credit is to do it conservatively. Only use credit cards to make purchases you can afford to pay off, pay your bill in full every month, and make sure you’re not overspending just to earn rewards.
With some self-discipline and positive habits, you can use credit responsibly and to your benefit.
- 14 New Year’s Money Resolutions
- Five Ways I Disagree with Dave Ramsey
- A 12-Month Plan to Raise Your Credit Score in the New Year
- Setting Attainable and Exciting Financial Goals