It’s obvious that there are people who have too much debt. For that matter, one recent study revealed that the average US household has more than $15,191 just in credit card debt not including other debts such as a mortgage, personal loan, business loan or medical debts. And college graduates are now carrying an average of $33,607 in student loan debt.
But did you know there are people who actually have too little debt?
Should you live cash only?
It might sound like a good idea for you to shred all of your credit cards and pay for everything with a debit card, check or with cash. But if you live like this, it can trip you up. The problem is that if you have no debt, you don’t have a credit score. And this can complicate your life considerably.
Your credit score – if you have one – is created from monthly reports that lenders send to the three credit reporting bureaus. It will reflect how many creditors you have, how much money you owe, how quickly you pay, the size of your lines of credit and any defaults. Plus, it will have information from the courts such as tax liens and bankruptcies.
Why credit scores are important
Credit scores are important because lenders depend on them to determine how likely you are to repay a loan. The credit score that is used most widely comes from the company FICO. It ranges from a low of 300 to a high of 850. If you have a score of 750 or above, you generally can get a new credit card or borrow money on the best possible terms. If you have a score of 700-plus, you will still be able to get a competitively priced loan. However, if your score is below 620, don’t bother even asking. And of course if you have no score at all, you don’t even exist – at least so far as lenders are concerned.
Understanding your credit score
While no one except FICO itself understands the algorithm used to create credit scores, it is known that they are made up of five components as follows: your credit history, credit utilization, length of credit, types of credit and recent applications for credit. Of these five, your credit history and credit utilization are the most important as together they make up 65% of your credit score. As you might guess your credit history is just that – how you have used credit in the past. Since it is, well, history there is not much you can do about it. But credit utilization, which makes up 30% of your credit score, is something that you do have some control over. The way it’s calculated is to take the amount of credit you’ve used and divide it by your total credit limits. As an example of this, if you have total credit limits of $10,000 and have used up $3000 of it, your credit utilization would be 30%. Most lenders would see that as good. However, if you had used up $5,000 of your available credit, your credit utilization would be 50%, which would be much too high. You can calculate your credit utilization yourself. If it turns out to be above 40%, there are two things you could do to get it down. First, you might be able to get more credit or second, you could pay down some of your debts.
Here, courtesy of National Debt Relief is a short video with more information about understanding credit scores.
Open some new types of credit
You could also influence your credit score in a positive way by opening some different types of credit. In addition to a credit card, you might open a personal line of credit or take out an auto loan. The fact is that potential lenders like to see that you’ve had some different types of credit and have used them sensibly. But do keep in mind that this accounts for only 10% of your credit score so don’t go hog wild in applying for new types of credit.
Your score could disappear
Let’s say that you had credit cards or loans in the past. In this case you might assume that you always have a credit score – despite the fact that you are currently operating debt free. Unfortunately, this is not so. If you had no activity on at least one line of credit in the past six months, your score could vanish. And this is according to FICO’s Anthony Sprauve.
The disadvantages of being a member of the un-scored
If you find that you don’t have a credit score, this might not bother you – especially if you voluntarily gave up your debt and credit cards. Unfortunately, your credit score will affect your life in a number of other ways. If you don’t have a score or a high enough score, you might not be able to get a discount on your homeowner or auto insurance. When you sign up for utilities such as gas or water, you might have to make a higher deposit. In the event you need to rent an apartment, your landlord will probably require a good score before giving you a lease. Credit scores are even often checked to get cell phone service or cable.
Marrying a credit score
Did you know that if you’re married you get a credit score by by sharing a debt with your spouse? As an example of this, you would get a credit score if you apply jointly for a credit card. In the event that one of you dies, shared credit cards are generally canceled. This means to keep them you would need to reapply. Otherwise, you would lose your credit score.
You might remember that song from the 1969 about one being the loneliest number. Well, in the case of credit cards one isn’t the loneliest number – it’s enough. No financial advisor or expert will suggest that you get a mortgage or take out a car loan just to make sure your credit score stays alive. All you really need is just one active credit card. For that matter, if you want to get a good credit score you don’t even need to have multiple credit sources. One card is enough assuming that you’ve had it for several years and use it once or twice a month – at least for small purchases such as gas or groceries – and then pay in full when the bill arrives.
Is it still good?
If you’ve been using cash, checks or a debit card to pay all of your expenses but have one credit card you’ve been keeping in a drawer for emergencies, you need to get it out and make sure it is still good. If you haven’t used the card for 12 to 18 months, the credit card issuer could lower your credit limit or even close your account. If you want to reactivate that card, it’s possible you would have to apply for it all over again.
For those with too much debt
Credit cards can be a trickier issue if you have too much debt. For example, should you cut them up or not? You would be at a danger point if your payments were more than 40% of your monthly income. Among adults aged 55 and up who carried debt in 2010, 8.5% hit that dangerous mark. People age 65 and up are carrying debt and in larger amounts than was true 15 years ago. And here’s an awful statistic – bankruptcy rates have risen to new heights especially among those 75 and up. If you’re trying to dig your way out of debt than cutting up cards might make sense. But make sure you keep one and use it at least once a month to keep your credit score alive.
I am an associate at National Debt Relief, which is a Debt Consolidation Company that has helped thousands of Americans facing credit card debt problems. We help with debt settlement, debt management, and other debt related financial crisis' facing consum