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Is Being Debt Free a Good Idea?

You’ve sold your home, paid off the car and all your credit cards and even closed most of them. You are completely debt free! This is great…right? Well, not when it comes to your credit score. Believe it or not, being completely debt free can actually hurt your credit scores.

While it may feel wonderful to be debt free, in reality you could be damaging your credit score. The credit bureaus’ scoring models like to see some balances. A good mix would be: one mortgage, one auto loan and at least one revolving debt with a balance, even if that balance is only $10.

The scoring models also favor consumers that have several open revolving debts with no balances. Closing accounts can actually hurt your credit scores. This is especially true of accounts with long histories. When you close accounts, the history also goes away. While any late payments that have occurred stay and still affect the credit scores, the good history will no longer be there. That being said if a consumer had an enormous amount of revolving credit cards, closing some of them might not be a bad idea especially if you don’t use them. Having too many cards makes a consumer much more vulnerable to identity theft. Pairing down to only six or seven cards would be a good idea as long as those cards have a long history on them. If a consumer is going to close cards they should be the ones with the shortest history and preferably be cards like store credit cards.

Years ago it used to be that the scoring models did not want to see a lot of open credit cards. It was perceived as a temptation to use them and run up balances. Now, that scenario is perceived as the ability to resist temptation. So having several open credit cards with no balances is actually beneficial. It is a good idea to use those cards occasionally though. A lot of credit cards will automatically close the account after 6 months or so of no activity.

The important thing is to keep a small balance on at least one credit card. A credit score can jump up as much as 30 points by putting a small balance on a revolving account if that person currently has no revolving balances.

While it may seem ludicrous to have a better credit score if you carry debt, it is the reality. Though most people would take pride in being able to pay off all their debt every month, the scoring models aren’t programmed to look at it that way. In the long run, a little debt can actually go a long way in helping to improve a credit score.

Credit scores can be very confusing and frustrating, but by following a few simple rules you can optimize your chances of acquiring and maintaining a good credit score:

  • Pay bills on time.
  • Don’t open new accounts unless you absolutely have to.
  • Don’t close accounts with long histories.
  • Keep revolving debt to a minimum.

The bottom line is that being strategic and responsible with debt will keep your credit scores in a good place.

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