Do Credit Scores Reward You for Having Debt?

Credit scoring has become ubiquitous in consumer lending, insurance underwriting, tenant screening, and utilities.

A solid credit score will help to open the door for inexpensive or interest free financing, cheaper auto and homeowner’s insurance and the waiving of deposit requirements.

Having a poor credit score means limited and expensive financing options, deposits, and difficultly finding inexpensive insurance.

Credit scores are, understandably, a lightening rod topic.

Aside from the incorrect information floating around the web (like credit scores are used by employers) credit scores do, in fact, have considerable influence on our access to and cost of credit and services.

This has lead to wide spread distrust and criticism of credit scoring systems.

One of the more common criticisms is that credit scores reward you for being in debt and thus act as an incentive for you to avoid being debt free.

And, the downside of being debt free is that you’ll have a “zero” credit score.

Thankfully neither of these statements is actually true.

The Truth

It is systemically impossible to have a “zero” numeric credit score when the common credit scoring scale is 300-850, a range that does not include the number zero.

The truth is credit scoring systems penalize you for being in debt, and especially so for being in credit card debt.

On the FICO scale your debt load counts for 30% of the points in your score. On the VantageScore scale your debt accounts for 31% of the points.

By anyone’s reasonable definition debt is considered a highly influential factor in your scores.

Being debt free means that you’ll earn most, if not all, of the points in the various debt related metrics.

Conversely, having debt means you will not earn all of the points in those categories. It’s pretty simple, yet being misrepresented.

Good Debt Vs. Bad Debt

Being in debt isn’t a bad thing. Being in a bad debt is a bad thing.

Would anyone really call borrowing money to buy your first home at 3% a “bad” debt? Would anyone really call borrowing money to buy a new car for the family at 0.9% a “bad” debt?

And while student loan debt is hugely problematic, it does in fact fund an education that should lead to a richer, more fulfilling and financially rewarding life.

The only truly bad debt is credit card debt and it’s not inherently bad on its face. It’s bad because it’s expensive.

The average interest rate on a credit card is right around 15% and that is likely the most expensive debt you’ll ever service unless you do business with pawn or title lenders.

Of course, of home loans, auto loans and credit cards the credit card is the only credit tool that allows you to use it without incurring any interest or fees.

That almost seems counterintuitive since most reasonable people would consider mortgage or responsible auto debt to be “good” debt and most would consider credit cards to be bad.

Voluntary Debt

Credit card debt is voluntary. I think sometimes we forget that.

Nobody from any bank, credit bureau or credit scoring company forced you to get into credit card debt.

That was your choice and that choice has consequences in the form of interest.

Further, it’s no secret that credit card debt incurs interest. That was clearly disclosed on the application you signed and on your statement each month.

In fact, your statement also includes a box that clearly discloses the cost of carrying your credit card debt and making only minimum payments.

If you choose to avoid using credit cards, that’s great. You’ll avoid credit card debt and credit card interest.

But, you’ll sacrifice efficiency when transacting in commerce.

You’ll have to carry cash, write checks, and/or depend on debit cards, which come with their own set of problems.

If you choose to use credit cards, that’s great too but only if you use them responsibly. By paying in full each month you’ll avoid credit card debt and interest.

You’ll also enjoy the efficiency and fraud protections offered by credit cards that simply don’t exist with cash or debit cards.

John Ulzheimer is the Credit Expert at CreditSesame.com, and a credit blogger at Mint.com, CreditCardInsider.com and the National Foundation for Credit Counseling.  He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO and Equifax, John is the only recognized credit expert who actually comes from the credit industry. The opinions expressed in his articles are his and not of Mint.com or Intuit. You can follow John on Twitter here.