So Being Debt Free is Bad for our Credit Score?

[Shelsi]

A friend mentioned how her credit score had gone down a bit because they didn't have any debt any longer.

Dh and I are just about to pay off the car with our tax refund (pay off is $4000) and then by this time next year my student loans will be paid off and we'll be debt free. We have a credit card but rarely use it and when we do we pay it off right away. We have a few other random cards, a Gap card, a Star Card (for the military BX), and a Lerner's card but all those get paid off immediately if there's a balance.

Is this going to be bad for us? Should we not pay off the car and student loan right away?

We're looking to buy a house either in the next 6 mos (not too likely though) or in the next 2-3 years (much more likely).

ETA: right now our credit scores are good at 780+. I'd like to keep them high so we can get a good interest rate and such when it comes to house buying time.

[mightymoo]

I'm not an expert, but I think its not so much about being debt free as it may be about having no recent credit history. Say you pay off your loan and never use your credit cards, you won't have any recent history showing you pay things on time, that's something a mortgage or car loan gives you. I think if you use a few credit cards regularly and pay them off you can counteract that.

[AngelBee]

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[Captain_Crunch]

Credit scores depend on a lot of factors
* debt-to- available credit ratio
* Length of credit history
* days delinquint/ overlimit and # of times delinquint/overlimit
* Types of Accounts (revolving, store cards, mortgage, etc.)

I'm guessing that what happened to you friend is that when they paid off the accounts they also closed them out, effectively removing X number of years of credit history from their file AND increasing their debt-to-available credit ratio. (zero-to-zero looks just like 5-to-5)

Ideally, what you want to do is pay off the account but keep them open whenever possible so you keep the # of years but show a low debt-to-available credit ratio as well.

[herwitsend]

If you have no recent credit history, you need to find a mortgage broker who does underwriting. They will be able to take into account your lifestyle (debt free and living below your means) rather than *just* your credit risk.

[Turquesa]

I'm no expert on this topic, but I did find a site that provides a breakdown of how you're scored on credit: http://www.kiplinger.com/magazine/ar...dit-score.html

I have always that the credit scoring system is fundamentally screwed up, but that's for another day, another thread.

[Shelsi]

Originally Posted by Captain_Crunch

Credit scores depend on a lot of factors
* debt-to- available credit ratio
* Length of credit history
* days delinquint/ overlimit and # of times delinquint/overlimit
* Types of Accounts (revolving, store cards, mortgage, etc.)

I'm guessing that what happened to you friend is that when they paid off the accounts they also closed them out, effectively removing X number of years of credit history from their file AND increasing their debt-to-available credit ratio. (zero-to-zero looks just like 5-to-5)

Ideally, what you want to do is pay off the account but keep them open whenever possible so you keep the # of years but show a low debt-to-available credit ratio as well.

But what happens when you pay off things you can't "keep open" like our car and student loans? So then it will just look like we have a few credit cards we never use? Argh, I'm so confused. Off to read the link the pp posted...

[an_aurora]

I was wondering about this too, because we were told we needed to keep our car loan open for at least 18 months or it would negatively effect our credit. But then again they also told us if we made 12 consecutive on time payments our credit score would go up 100 points and that hasn't happened :

[Treasuremapper]

http://www.creditboards.com/
The credit boards forums discuss credit scores and they are experts on the topic. They even have a mortgage subforum. You might want to check there.

[Sarah W]

Originally Posted by Shelsi

But what happens when you pay off things you can't "keep open" like our car and student loans? So then it will just look like we have a few credit cards we never use? Argh, I'm so confused. Off to read the link the pp posted...

No, it will still show that you had those loans but the balance is zero. It will show what your max balance was (The loan amount) and that it was paid off.

[Siera]

Originally Posted by Captain_Crunch

Credit scores depend on a lot of factors
* debt-to- available credit ratio
* Length of credit history
* days delinquint/ overlimit and # of times delinquint/overlimit
* Types of Accounts (revolving, store cards, mortgage, etc.)

I'm guessing that what happened to you friend is that when they paid off the accounts they also closed them out, effectively removing X number of years of credit history from their file AND increasing their debt-to-available credit ratio. (zero-to-zero looks just like 5-to-5)

Ideally, what you want to do is pay off the account but keep them open whenever possible so you keep the # of years but show a low debt-to-available credit ratio as well.

I agree. I would suggest not closing out credit cards. Car payments and mortgages understandably close, but not credit cards unless you call and cancel them. So, I would pay off my car and house, and keep all my credit cards open. Perhaps use just one a month to charge a dinner out and be sure to pay in full when the bill comes? That way, you have activity, AND you are boosting your score because you would be paying in full each time. But, just be sure not to close out the cards as that damages your credit/debt ratio. To suggest that you not pay off current debt is just silly.

[milletpuff]

If your score is 780, you have a ways to drop before you drop out of the "very best" category. I really wouldn't worry about it at all. If you are concerned, bring your credit report and score to a mortgage broker and ask if they have recommendations.

[crazyeight]

ah the wonderful perils of credit. i'm no expert but i would pay it off if you want to pay them off. the car loans and student loans being paid off will at least lower your debt ratio. HOWEVER when all the credit cards are paid off take a look at how much spending power you have. finding the balance between having enough to be a "good consumer", a reckless one or having to few credit cards is a hard balancing act. if you only make $1k a month but have a $5k spending limit (but no debt) you could concevieably have 50% debt (debt vs year income) the next day. I seem to recall 25% is a good number????? And i would charge random amounts of items on your cards at least every couple of months so theres odd amounts that get paid off.

[Shelsi]

Ya know what's odd? We've never had a limit higher than $5K on our card. Just seems odd since we have such good credit and all. Dh makes about $7K/month so technically we could never be "in over our heads" in credit card debt. You'd think they'd want to entice us or something, esp because we did use to carry a $1-2K balance on the card. We don't have any credit card debt at all anymore. So basically maybe some months we should just pay for a bunch of stuff with our credit card?

[ShaggyDaddy]

also another note, most mortgage lenders have recently more heavily ranked debt to income ratio over FICO. I am not saying FICO is ignored, it is still up there, but debt to income ratio is really a lot more scrutinized than it used to be (which would be good for you).

[AuntNi]

Originally Posted by Shelsi

So basically maybe some months we should just pay for a bunch of stuff with our credit card?

That's what I would do. Pay off all the debt you can - that's not going to hurt your score. Keep your credit card accounts open. Charge a tank of gas or something every month, and pay it off every month.

[MacroMama]

When we paid off our car loan our FICO score went down a few points because our debt to credit ratio had changed. If your FICO score is good, then I wouldn't worry about it because it shouldn't make much of a difference.

[marisa724]

Originally Posted by Shelsi

Ya know what's odd? We've never had a limit higher than $5K on our card. Just seems odd since we have such good credit and all. Dh makes about $7K/month so technically we could never be "in over our heads" in credit card debt. You'd think they'd want to entice us or something, esp because we did use to carry a $1-2K balance on the card. We don't have any credit card debt at all anymore. So basically maybe some months we should just pay for a bunch of stuff with our credit card?

Absolutely! Never charge more than you can handle, of course, but pay for everything you can with your CC. I use it to buy groceries, pay the heating bill, pay the car insurance, pay the cable... It takes out most of those through automatic deductions, and then I write one big check to the CC company every month.

Apart from a few incidentals here and there, our general household expenses (money I'd spend anyway) make up the bulk of what I'm charging, and I pay it off in full every single month. We also earn back a percentage of that amount in cash rewards, since we have a Discover card.

We both have credit scores in the 790's and our only ongoing debt is the mortgage, so it would seem that this method is working out for us.

[laohaire]

You know what's ironic and frustrating? From what I understand, "they" view being debt-free as a liability because "they" assume you can't HANDLE debt!!



However, that would not stop me from being debt-free (not that I have to face that decision for a while...). I would just keep open a revolving line of credit and pay it off every month. Maybe they would dock me some but surely I'd still have good credit.

[dogmom327]

Originally Posted by marisa724

Absolutely! Never charge more than you can handle, of course, but pay for everything you can with your CC. I use it to buy groceries, pay the heating bill, pay the car insurance, pay the cable... It takes out most of those through automatic deductions, and then I write one big check to the CC company every month.

Apart from a few incidentals here and there, our general household expenses (money I'd spend anyway) make up the bulk of what I'm charging, and I pay it off in full every single month. We also earn back a percentage of that amount in cash rewards, since we have a Discover card.

We both have credit scores in the 790's and our only ongoing debt is the mortgage, so it would seem that this method is working out for us.

This is what we do. We have an Amazon card through Chase that gets us 1% back on general purchases and 3% back on Amazon purchases in the form of Amazon gift cards. Works out nicely. I just log on and pay the balance every week. Once I got in the habit, it's not a big deal.