Does Your Credit Score Drop When You Live Debt Free?

Anyone who’s experienced living in debt understands the desire to live debt free, but a debt-free lifestyle can actually cause damage to your credit score! Once you’ve paid off all loans and credit cards, there is a good chance you’ll find your credit score drops as time passes instead of improves, which will make it harder for you to obtain credit in the future should you need another loan or want to buy a house, for example.

Credit scores are calculated based on a number of different aspects of your financial life. The score is used by creditors to judge what level of risk you are to them if they extend you credit, and even car insurance and employers have begun to use the credit score as a way to determine how much your car insurance premiums should be or whether or not to hire you for a job. Your credit score plays an important role in your life.

When you have paid off your debts and are living a debt free lifestyle, the formula for calculating a credit score doesn’t have as much information to use for the calculation. A large percentage of your score is made up of how you pay back your creditors. If you don’t have any creditors, you’re missing this piece of information and you might have a lower credit score than individuals who may have a bit of debt but who are making all of their payments on time!

While you may be enjoying a credit-free lifestyle, it’s possible that some day in the future you may require a loan. From car loans to mortgages – there are instances when you may prefer to finance the purchase over saving and paying for it. A low credit score will make this difficult to do – and if you are approved for a loan, it means you’ll have a higher interest rate that someone with a higher credit score. Additionally, because credit scores are playing a more important role in employment, car insurance, and even renting an apartment – you may find the lower credit score harms you in other ways besides obtaining financing as well.

If you feel your credit score is lower than it should be because you do not have any debt, you might consider taking the following two steps to increase your credit score:

Get a credit card – you may be shaking your head in disbelief since it’s possible you’re living debt free because you just managed to pay off a ton of credit card debt – but having a single credit card on hand to make small purchases will go a long way toward maintaining your credit. Just be sure to use it for a small purchase once a month or so, and pay it off in full and before the due date.

Apply for a personal loan – you might also consider taking out a small personal loan from the bank. Deposit the funds into your bank account and have the payments withdrawn directly from the account each month (from the loan funds itself). This will ensure you never miss a payment which will improve your credit score, and you won’t have to worry about coming up with the money to repay the loan. The downside of this strategy, of course, is that you’ll end up paying a bit of unnecessary interest. For that reason, the credit card route is much preferable.