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Credit and debt are not synonyms. This is important to know.
It’s understandable people confuse the relationship: It’s good to have a high credit score, and you need to use credit in order to have a score. Sometimes, using credit leads to debt. However, you do not need to have debt to have a credit score (or a good credit score, for that matter).
Revolving credit is the key to a superb score without debt, so using a credit card, even if it’s not that often, is a good practice for building credit. You need some sort of plastic (for online shopping and hotel reservations, for instance), and while debit cards are an option many use to control their spending, debit cards don’t help you build credit, nor do they carry the same financial protections as credit cards.
There’s a misconception that you need to have debt in order to have a good credit score, says Gerri Detweiler, Credit.com’s director of consumer education.
“When you pay bills on time and you have little debt, that means you probably have a high credit score,” Detweiler says. Payment history and debt usage have the most impact on credit scores, so keeping debt levels low or nonexistent should be a huge positive.
Swearing off debt doesn’t mean ending your relationship with credit. Well, it depends on your definition of debt-free.
“If you have made a decision that you’re not using any credit, and that’s your version of debt-free, there are ramifications for that,” said Anthony Sprauve, FICO senior consumer credit specialist.
Those ramifications stem from the lack of a credit score, which makes loans difficult to obtain should you need to borrow money.
For the large chunk of consumers hoping to buy a house or a car someday, learning to use credit early and responsibly will help. You can build a solid, positive credit history with the use of one card, if you really want to be a minimalist. Keep in mind that mix of accounts play into your credit scores, so having only a credit card doesn’t do much there, but payment history and debt usage play a much larger part in that high score you’re aiming for.
“While it’s good to have a mix of credit, you should have at least one credit card,” says Rod Griffin, Experian’s director of public education. “It gives greater insight into how you make borrowing and repayment decisions.”
You choose how much to spend and repay with credit cards, whereas installment loans like auto loans and mortgages provide a set amount and tell you what must be paid each month. Paying credit card bills on time and in full conveys a certain sense of responsibility to lenders, which is why payment history and debt usage are so important.
You can see how these components work together if you look at your credit scores, which you can do for free with the Credit Report Card — the category that says “debt usage” indicates how much of your available credit you use. Low or no debt translates into a better score, so you just need the available credit to make it work.
If you don’t like the idea of having to pay a credit card bill each month, you could go as far as paying the balance as soon as transactions show up on your card. Actually, if you have a really low credit limit, paying the balance more than once a billing cycle will help keep your credit utilization low, which also helps your credit scores.
“As long as you’re actively using credit, having little or no debt means you won’t run into any problems,” Detweiler says. “Carrying debt does not improve your credit score.”
Image: iStock
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