You may have heard this advice or something like it before, “If you’re doing it right, you will never borrow money again. You will have no debt, and you will pay cash for everything — for a new car, a house, or whatever it is you want to purchase. Therefore, you won’t need a credit score.”
I can fully stand behind the benefits of living a debt-free life. You aren’t beholden to anyone; you aren’t shelling out money in interest charges; and you aren’t living beyond your means. However, I do question the dismissal of credit scores and the importance of having good credit.
If you’re struggling to get your finances in order and certain advice has left you without access to credit, it’s not too late to turn things around. Let’s take a look at what credit even is, why it matters, and how to build credit if you don’t have any — so you can make the most informed decisions with your finances.
What credit history is
People have been borrowing for various reasons for more than 5,000 years. Credit is usually described as the ability to borrow money, but it also includes the ability to access goods and services with the understanding that you’ll pay at a later date. Electricity, wireless service, and water and sewer usage are all examples of services you typically pay for after using them.
Your credit history reveals how well you’ve held up your end of that bargain — repaying the money you’ve borrowed or making the agreed-upon payments for the goods and services you’ve received. It paints a picture of what type of borrower you are. In the U.S., this track record (good or bad) is boiled down into a three-digit score. This is your credit score, and it’s a snapshot of your credit profile.
Credit scores can feel like a symbol of success because they play a big role in the lives of many Americans. They play a part in the interest rates we get on our car loans and mortgages, as well as the quality of credit cards and loans we can get approved for. Landlords look at credit scores when gauging a potential renter, employers look at credit scores of potential hires, and utility companies even check your credit to see whether you’ve always paid your utility bills.
Understanding where your credit score comes from
You may already know you have more than one credit score. The phrase credit score is often used to refer to a FICO score, which was introduced in 1989 by the Fair Isaac Company. However, in 2006, the three major credit bureaus — Experian, TransUnion, and Equifax — introduced the VantageScore as a competitor to the FICO scoring model.
In any case, credit scoring models are made up of similar components. The main factors that impact your scores are generally the following:
- Payment history
- Credit utilization (how much of your available credit you are using)
- Length of credit history
- Types of accounts (car loans, mortgages, credit cards, etc.)
- Newly opened accounts
These factors are weighted differently depending on the scoring model. For instance, payment history accounts for 35% of your score under the FICO model, whereas payment history makes up 41% of your VantageScore. So although payment history holds a little more weight with your VantageScore, it’s obvious just how important of a factor it is to your overall score, whichever model is used.
7 times you’ll need a good credit score
Having a strong credit history is not about having the bragging rights to say, “I have an 825 credit score.” Rather, it’s about what life options are made available to you as a result of that score.
The reason for wanting a strong credit history is to have more — and better — options available to you. From credit cards to mortgages, lenders want to see that the risk of lending you money is low. When your credit history paints you as an ideal borrower, lenders will be more willing to not only lend you money (or issue credit), but also to do so with better terms attached.
Here are just a few of the times when having a credit history will matter:
- You want to rent an apartment. According to TransUnion, landlords typically look for five things in a credit report when screening potential tenants: late payments, financial stability, evidence of evictions, criminal convictions, and lawsuits. Although a strong credit history won’t erase the last few on that list, it does improve your chances of being approved. Landlords want to know you’ll make on-time payments every month, and your credit history is the best evidence of that. Without a credit history, you might have to rely on others to co-sign with you or offer to pay several months of rent upfront.
- You want utilities to go with that new apartment. Utility companies don’t just hand out service willy nilly. Even if you got a new place, you still have to apply for utility services. If there’s no evidence of positive payment history reflected in your credit report because you’ve limited yourself to always paying in cash, you may have to pay a deposit, provide a letter of guarantee from someone who agrees to pay your bill if you don’t, or be denied service altogether.
- You want to lease a car. You might think that because you’re not taking out a car loan that you won't need credit to get a car. But that’s not the reality. You’ll need to have a good credit score to lease a car in most situations.
- You don’t want to overpay on car insurance. According to Consumer Reports, car insurance companies use information in your credit file to predict the odds you’ll file a claim. If your credit is less than ideal, they will charge you more. Even if you have good credit, you could be paying more than $200 more each year than those with the best credit. Simply put: Having credit means you can save money on car insurance.
- You really want that new job. A 2018 HR.com study sponsored by the National Association of Background Screeners (NABS) found that 16% of organizations conduct a credit check on all potential employees during the hiring process. 31% said they perform a credit check on some candidates. The point is, your potential employer might pull your credit before handing you a job. Having a sound credit history can put you one step closer to landing that dream job.
- You want that amazing smartphone plan providers keep advertising. Those amazing prices, “free” iPhones, and zero-down deals you’re always seeing look great, but more than half of Americans can never get those deals, according to T-Mobile. For those with less-than-perfect credit, the only way to avoid walking out the door empty-handed is to fork over more cash, both upfront and over the length of your contract.
- You dream of becoming a homeowner. Unless you’ve saved up enough money to buy a house outright with cash, you’re going to need a mortgage. And although it’s possible to get a mortgage without a credit trail, you’ll likely face a lot of challenges. Mortgage lenders will be reluctant to hand you money if you have no traditional track record of paying back debts. You may have to resort to an FHA loan, which is a loan backed by the Federal Housing Authority and is typically more expensive than a conventional mortgage. Manual underwriting is an option, but your proof that you can pay for the mortgage and proof of payment history will need to be extensive. Depending on the information you provide, you might not get the most favorable terms — or you could be denied altogether.
In short, not paying attention to your credit history can result in the denial of services, being turned down for loans, or spending a lot more on the loans you do qualify for. It’s actually not very hard to nurture your credit score, so there’s a lot being put at risk for little reason.
If you’re starting to feel differently about the importance of your credit score, there are things you can start doing today to improve your creditworthiness in the eyes of lenders.
Tips on how to build your credit
If you’ve been following the advice to disregard your credit score, you may be lacking in credit history, but it’s not too late to build yourself a great credit track record. Here are some things you can do:
- Open a secured credit card. Depending on how little credit history you have, you might not qualify for a regular unsecured credit card. In that case, opening a secured credit card can help you build or rebuild your credit. Secured credit cards require a refundable down payment that equates to your credit limit, but you use the card just as you would a regular credit card. As you make your payments on time and in full each month, you’ll establish a positive credit history. In time, you’ll be able to graduate to an unsecured credit card.
- Open a credit builder loan. With a credit builder loan, the financial institution deposits a small loan — generally between $300 and $1,000, according to the Consumer Financial Protection Bureau — into a locked savings account. You make payments to the lender over six to 24 months until you come to the end of the loan term, at which time you receive the money in the account. Your payments are reported to the credit bureaus and your credit history improves as a result.
- Become an authorized user on someone’s credit card. If you have someone in your life willing to add you to their credit card account as an authorized user, it can help improve your credit. Most major credit card issuers report authorized users to the credit bureaus. Even if you never receive a card, simply being on an account can do the trick, as long as the account holder makes their payments on time and in full. Be aware that if the account holder regularly carries a balance or misses a payment, this negative activity will be reflected on your credit as well.
- Trying boosting your credit score with Experian boost. Experian Boost is a free service offered by Experian that allows you to get credit for your payments toward phone and utility bills. According to the Experian website, users who received a boost improved their scores by 13 points on average. You simply connect the bank account you use to pay these bills to Experian Boost and choose the positive payment history you want added to your credit file.
The bigger picture: your future and your credit score
You may have been led down a path of avoiding loans and credit entirely, which can leave you without a credit score. But dismissing the importance of your credit score can make you vulnerable if you need to borrow because it puts you in a position in which you can’t prove you’re financially trustworthy.
Relying solely on cash isn’t always the best route, financially. It’s simply not always feasible. And, in my opinion, it’s too restrictive. Instead of fearing debt and avoiding credit, retrain yourself to understand how access to credit can play a role in improving your financial position. If you learn how to manage your money, you’ll see that having access to credit is an asset; it doesn’t mean you’re in bad financial shape.
I’m not advocating for you to take out a loan to buy a luxury vehicle or to take on a $500,000 mortgage. But simply saying, “Don’t buy a car unless you can buy it with cash;” “Continue renting until you can buy a house with cash;” or “You don’t need a credit score” is too simplistic, and it’s an approach that doesn’t work for everyone. Even if it works for you right now, it might not work for you if your lifestyle and priorities change in the future.
Having credit doesn’t automatically equate to living a life drowning in debt. Having strong credit can actually help you improve your financial situation. Even if you’re in a position to not need a credit score, having solid credit could put open up more opportunities in your life.
Credit is the ability to borrow money. It’s also the ability to access goods and services with the understanding that you will pay later. Regardless of your financial situation, having good credit is not a bad thing. It means you stick to your word as a borrower and repay your debts according to the agreed-upon terms.
If you get into a position in which you no longer rely on credit, that’s great. But there’s nothing wrong with showing you are a trustworthy borrower. In the event you do need to borrow money, strong credit will not only make more options available to you, but also better quality options.
As you start to build credit, also get in the habit of keeping track of it. You can check your credit score for free and as often as you want with sites such as Credit Karma.