Paying ‘outright’ isn’t the only way to steer clear of debt

This post originally appeared January 1, 2014, on as “Paying by cash won’t build credit score”

By Barry Paperno

Dear Speaking of Credit,
Hello. I just tried to pull my credit report through Credit Karma and it wouldn’t give me a score. It says “thin file.” I always pay for everything outright and do not want to have credit cards. — Monika

Hello Monika,
Despite having made somewhat of a career out of advising people about credit, I have to say I really admire people who are able to pay cash for what they need and successfully avoid the often complicated and tedious world of credit management. There is certainly a lot to be said for simplicity and a whole lot to be said for being debt-free.

Yet in discussions weighing the pros and cons of credit versus cash, I find that many of the staunch credit critics advocating the cash-only lifestyle tend to equate credit use with taking on mountains of debt and paying exorbitant interest. While this happens and credit is not for everybody, the efficient use of credit cards and loans can provide the convenience, safety and money savings that checking accounts, prepaid cards and debit cards can’t — and without incurring any debt, interest or fees.

Here are just a few reasons why you may want to consider adding at least a minimal amount of credit activity — minus the debt — to your financial picture:

  • Credit cards paid in full each month can earn rewards and cash back on purchases you’re making already, such as groceries, gas and travel.
  • Having a credit card on hand can make an already unpleasant medical emergency, auto or home repair situation much less stressful.
  • Traveling with a credit card allows you to carry less cash and if stolen, provides protections against financial liability that debit and prepaid cards may not.
  • If you plan to finance a home or car, you’ll need a good credit score based on credit experience to qualify for affordable rates.
  • Compared with other payment methods, credit cards offer better recourse against faulty products or services.

In your email, I couldn’t help but detect some exasperation over having no credit score despite being debt-free, which, common sense might imply, should put you in a very low-risk category, with a good credit score to match. It might also feel like you’re being penalized by the credit scoring system for not going into debt and playing the credit card game.

While equating low risk with paying outright may seem like just plain common sense, the numbers disagree. Research into how millions of consumers have managed their credit over many years has shown that while it’s true that deeply-in-debt consumers are more likely to be headed for bigger financial trouble than those with zero debt, consumers with low debt and a proven credit track record tend to be better risks than those with low or no debt due to a lack of recent credit experience. In other words, there is no way to know how well a consumer who hasn’t used credit in the past, or recently, will handle credit in the future.

What exactly constitutes a credit track record? Actually, you might be surprised at how little experience is required for a credit score. All it takes is single card or loan opened at least six months ago and reported to the credit bureau within the past six months to meet the minimum FICO credit scoring criteria.

For those not new to credit, but who have used credit in the distant past, just not recently, it’s also helpful to know that these two minimum scoring criteria — an account that has been 1) opened at least six months ago, and 2) reported within the past six months — can be satisfied by a single account or by multiple accounts. For example, let’s say that instead of having your very first account opened six months ago, your credit report shows one old paid-off loan or closed credit card and a new card you just opened. This minimal amount of credit experience is all it takes for a FICO score to be calculated immediately.

But if your thin file means you don’t have a credit score, how do you get approved for credit when doing so requires a score? Actually, it’s pretty easy. What follows are a few of the most commonly used ways to build and rebuild a credit history:

  • A secured credit card issued by a bank or credit union. All you need is some cash to put down as a deposit and pay a nominal annual fee. Secured cards that you can pay in full each month without interest appear on your credit report and contribute to a credit score just like unsecured cards. What makes them ideal for this purpose is that most do not to require any — or good — prior credit history.
  • Authorized user credit card. Whether you actually use this card or not — it’s up to you — by having a spouse or partner add you as an authorized user to a credit card in good standing, the entire history of the account will instantly become part of your credit file, while you bear no responsibility for the balance. As with most secured cards, no prior credit experience is required of an authorized user.
  • If you still don’t want to have credit cards, but wouldn’t mind having a credit score to help you qualify for car or home financing in the future? Many credit unions offer “credit building” personal loans, in which you take out a small loan secured by a cash deposit and make monthly payments over time — though, expect to pay interest and an origination fee. As with a credit card, this loan will appear on your credit report and could, by itself, deliver a score after six months.

Still, in the end, whether you continue to pay as you go and avoid credit cards entirely, or begin to incorporate some credit usage into your financial picture, the name of the game is steering clear of debt. Good luck, Monika!

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