5 Little Known Tips on How Having No Debt Affects Your Credit Score

Can Having No Debt Improve Your Credit Score?

If you have no debt, you should be considered a financially responsible person and a prime candidate for loan acceptance, if you should decide to borrow money for any reason, right?

That depends. If you don't have any debt simply because you have never borrowed any money from a commercial lender, then you also don't have any credit history. And if you don't have any credit history, most lenders will consider you a high-risk prospect because they have no way of knowing how responsibly you handle financial obligations.

FICO Score Effects

But if you have a credit history, and have simply decided to pay off all your debts, your decision will be reflected in your credit score. Your payment history--which for most people is a record of month after month of payments on various accounts--constitutes 35% of your FICO credit score. And you FICO credit score is a major factor in determining how much money you will be able to borrow in the future.

But what if you pay off all your debts, so that your record of monthly payments is suddenly halted in its tracks? What will that do for your FICO score?

Strangely, it will not do much to improve it in the long run.

Why Is Recent Information More Important to a FICO Score?

Your FICO score places much more emphasis on your recent financial transactions than it does on what you may have done in years past. Lenders love to know what you have been up to lately, and if you decide to close out all your loans, they won't have much information at all to help them. You'll still, almost certainly, be paying utility bills, and insurance, but neither of those is considered a long term debt, and in turn not affect your FICO score.

So how can you minimize your debt without minimizing your credit score? Keep a few low-interest, no-annual-fee credit cards open; maintain tiny balances on them; and pay them off each month. Most credit cards have grace periods during which no interest is charged, and if you pay off your purchase each month within those grace periods, you will boost your credit score without building your debt.

Watch Out When Dealing With Old Defaults

You may also be surprised to learn that if you once defaulted on a debt, and now have the financial means and desire,to pay it, doing so can actually hurt your credit score. How? Any time you take action which involves your credit, it shows up as a recent transaction.

Deciding to pay off an old default in your quest for no debt, may make it appear to be a new one, and new problems weigh more heavily against your credit score than old ones. If the default you want to correct is over seven years old, it's more than likely been dropped from your credit report and is no longer used in determining your score. If it's more recent than that, see if the collection agency which was managing it would be willing to agree in writing to remove it from your report before you decide whether or not to pay.

It may not seem sensible that having no debt, or wanting to pay off old ones, can hurt your credit score. But credit is all about what you have done for your creditors lately, so a little or no debt, responsibly managed, will actually look better than none at all.