Is Being Debt-Free Always a Good Thing?

Is being debt-free always a good thing? Seems like a silly question. Kind of like asking if being healthy is a good thing.

Living without a lot of unmanageable debt is obviously a great financial position to be in, but we get a number of blog comments from readers who think that credit scores punish people who choose to be debt-free.

• Sounds like punishment for not being in debt. So glad I got rid of all those credit cards…. -D
• My credit score: Cash only. -N. PA
• You can’t win with FICO scores, especially if you remain debt-free and live beneath your means. -Codeine P

And they aren’t alone, as even some high-profile consumer advocates preach that credit scores discriminate against people who choose to remain debt-free.

[Related Link: The 11 Most Common Credit Questions]

The fact is, the facts aren’t on their side.

Studies going back more than 20 years, using tens of millions of consumer credit reports to identify predictive consumer behavior, have consistently found that lower amounts of consumer debt lead to reduced credit risk.

While having zero percent credit utilization (revolving balance/limit ratio) and all loans paid off won’t necessarily guarantee the highest possible scores — many other factors also go into a credit score — a credit report absent any debt or late payments can easily be expected to deliver the kind of credit score that will qualify for some of the best rewards programs available — which saves you money.

[Related Link: Can You Really Get Your Credit Score for Free?]

The following frequently asked questions, and their answers, address the issue of whether you can remain debt-free and at the same time have a good, or even great, credit score:

Do you have to owe money to have a good credit score?

In a word: no.

In fact, credit scores look very kindly on credit reports containing nothing but credit cards and loans with zero balances — and spotless payment records — as long as one or more cards remain through at least occasional use.

Do your credit accounts have to be active to have a score?

While scores don’t like to see a lot of debt, they do like to see some amount of credit use, or “activity.”

With cards, the more frequently they are used, the less likely they are to be closed due to inactivity by the card issuers.

Do you have to have a credit card to have a good credit score?

Nope!

While a well-managed credit card or two can definitely contribute positively to your score, without a credit card, a good credit score can still be built using any type of credit that’s reported to the credit bureaus, such as loans, home equity lines of credit and retail cards.

Does it help your score to pay finance charges?

Not one bit.

Neither the finance charge rate nor the amount appears on a credit report. Of course, account balances not paid in full each month may include finance charges, but that level of detail doesn’t appear on the credit report.

Will a debit card or prepaid card help my credit score?

No — sorry!

While they may look and often function like a credit card, using a debit or prepaid card is essentially spending your own money.

With credit cards, you are being extended credit, even if only temporarily. For this reason, debit and prepaid cards don’t appear on credit reports, and are not included in credit scores.

To be clear, paying all credit card charges before finance charges are incurred is the goal here, with many consumers using some of the following techniques for using credit to their advantage, while remaining debt-free:

• Paying for your charges the same day you make the purchase using online banking. Or, if it’s a department or other retail card you’re using, you may be able to make the payment right then and there in the store. With this method, the balance for the account will appear on your next statement as zero, while maintaining a positive payment history and zero percent credit utilization.
• Prior to the next statement date, making multiple smaller payments for convenience. As long as all charges are paid by the next due date, balances will be reported as zero, payments as current, and utilization as zero percent.
• Waiting for the charges to appear on your next statement, and paying the entire balance before the due date on that statement — either in one or multiple payments. While not quite as good for your score as the above methods, due to your credit report now showing a balance for the account, as long as you pay by the due date on your statement you will still avoid finance charges and remain essentially debt-free.

[Related Link: The First Thing You Must Do Before Applying for a Credit Card]

A reader even wrote to us with her own strategy for maintaining a great credit score while staying debt-free:

“I routinely use credit cards for just about everything and pay the balance off every month. This past year, I bought a computer and some other things with the points I had accumulated. My credit score is 809 which gives me peace of mind.” — Donna