Does Being Debt Free Help or Hurt Your Credit Score?

Debt free? Don't cut up those cards just yet.

Common sense dictates that the less debt you have, the more disposable income you have available to pay for things you want or need. If you think your debt-free lifestyle increases your chances of getting an auto loan, mortgage loan or credit card however, you'd be dead wrong. Oh, don't be so shocked. Since when has any American financial system worked the way it was supposed to?

Completely Debt Free? You May Not Have a Credit Score

A common mistake I keep running into again and again is this: Consumers tend to think that their credit scores start out at the maximum level and only drop when they start misbehaving with debt. This is a dangerous misconception.

Here's how it really works: You start out with NO credit. When you do manage to get a credit card or loan, your lender reports the account to the credit bureaus. If there is no individual in the credit bureaus' database whose information matches yours (such as your name, SSN, etc.), the credit bureaus "create" a brand spanking new credit report. You only receive a credit score after you've made or missed several payments.

If you never use debt, no creditor ever tries to report an account to the credit bureaus in your name. This results in you not having a credit report. Should you ever need a loan or credit card, your lender will attempt to pull your credit report and scores and will come up empty handed.

No Credit = Bad Credit

Lenders don't just look at your credit reports to see how much debt you carry, but also to determine how you've managed your previous debts. The way you've managed debt in the past is a strong indicator that you'll continue the same behavior in the future. If you have no credit history and no credit score, you don't fit into the lender's neat, orderly little box. You're a wild card. Perhaps you're excellent with money, but there's just as good a chance that you're completely irresponsible and you'll default on the loan or credit card. More than just your approval rides on your credit report. Your credit report and scores also determines your interest rate. If you have no credit, you're lucky just to be approved for something. And in the unlikely event that approval takes place, your interest rate will likely be through the roof.

Limited Credit Can Result in a Lower Score

Don't assume that you're safe just because you have a credit report and the information it reflects is positive. If the accounts on your credit report are closed because you're living the debt-free life, they will eventually age off your report. Most bad information only hangs around for seven years while positive closed accounts will remain on your credit report for ten years.

A portion of the credit scoring formula looks at the age of your accounts. The older each debt gets, the less impact it has on your overall score. Thus, you may have a good credit score today, but if your new debt-free lifestyle doesn't take credit management into consideration, your credit scores are in a steady state of decline.

"But I'll Never NEED Credit. I Pay In Cash."

This is what they always say...those debt free people with no credit or limited credit. They are secure in the fact that they can continue paying cash for everything they need indefinitely. And if you are a multi-millionaire, you go right on ahead with your bad self. If you're a regular Joe like the rest of us, you're in the trouble pit.

Cash is king...until its beheaded and overthrown

Unless you keep a crystal ball tucked away under your jacket or married a psychic, you have no way of knowing what the future will bring. No matter how much you don't want to play "the game" or how dedicated you are to paying only in cash, the time may come when you'll need a credit card or loan. Don't sacrifice your good credit on a gamble. Take the time to build and maintain your credit like a vintage muscle car. It's worth it. You may be secure in your debt-free life, but have a little extra security in the form of a great credit score never hurt anybody.

Related Articles:

How to Get a Real Free Credit Report Without a Credit Card

Credit Reporting Period vs. Statute of Limitations

Share on :