When you think about things logically, it seems perfectly natural that not borrowing money often, and paying it back on time and in full when you do, would set you up for credit success. Unfortunately, the system doesn’t always go by the same logic and this isn’t necessarily true.
In fact, those with high credit scores, even 750 plus (which is considered outstanding), can find themselves in a bind when they need to borrow money. This is especially the case when you have only taken out one or two large loans (or none at all) and pay off your credit card debt each month.
The reason for this perplexing problem is that many lenders – most, really – value a heavy credit record. What this means, basically, is that they look for people who have used a lot of credit and kept up with it. They want to know that you have a lengthy track record of borrowing and paying it back on time.
What it all comes down to is that you can be penalized for living a debt-free life. As backwards as that seems, it’s the truth. Our credit reporting system simply has a number of strange and oftentimes confusing faults.
But these faults point to an important factor in how things are currently run: to borrow money, you need to have borrowed money in the past. It’s currently the only way to show that you are “credit-worthy.”
These credit conundrums are discussed in greater detail below. The points discussed include:
- Why light credit makes taking out a mortgage more difficult
- When comparison shopping hurts your credit score and when it doesn’t
- Why paying off loans early does not hurt your credit score
- Why you should start slowly with credit cards when you are young
- The difference between more credit and more debt
Read on to help clear up your credit confusion and learn more about why avoiding credit might not be the brightest idea around.
Light Credit Makes a Mortgage Harder
No matter the case, the first thing that all lenders look at when someone wants to take out a mortgage from them is their credit history. Even if your credit score is simply outstanding, chances are slim that you’ll receive the help you’re looking for unless you have current open credit accounts.
Comparison Shopping Hurts Your Score
A lot of people who have a great credit score but a light credit history find themselves shopping around from different lenders. They have to. If they want a loan, they really have no other choice. But shopping around can have a negative impact on your report.
Luckily, it’s usually only a slight one. And it doesn’t stick around so don’t worry too much about doing a little comparison shopping if you’re having a hard time finding what you’re looking for because of your light credit.
The exception to the rule is if you are young and have relatively new credit. In this case, the credit reporting bureaus lump inquiries together over a period of a year. This means that comparison shopping for loans can put quite a strain on your score.
If you’re not sure where you stand considering comparison shopping, your best bet is probably to see a financial advisor about it before making any moves.
Paying Off Loans Early Does Not Hurt Your Report
A commonly related “credit myth” is that paying off loans early will actually hurt your credit score and credit report. This isn’t true. As soon as you pay of a loan, your credit report is updated to show this. And a note of your “good behavior” actually stays on your report for ten years – definitely not a bad thing.
Start Slow With Credit Cards
Way too many college students rush or are prodded into signing up for credit cards left and right. While college is an excellent time to learn strong money management skills with the help of a credit card, there is simply no need to have more than one (or, in some cases, two) college credit cards at a time.
Taking on too much debt will do no one any good. It will bog you down, damage your report, and make taking out loans a huge hassle in the future. It’s best to start with a single card, learn how to use it responsibly, and then build from there.
You Don’t Need More Debt for More Credit
Despite what we talked about in the introduction to this post, debt does not equal a better chance of receiving more credit. It’s actually a history of credit that allows you to take out more credit.
Lenders don’t want to see a history of missed bill payments and staggering credit card debt. They want to see that you have taken out credit multiple times in the past and then paid it off in a responsible manner.
There is no denying that the world of credit is confusing. While it is hard to follow enough for those that are experienced with it, it is even more difficult to pick apart for young people just starting out on their own. The above points a few of the most common areas where people, both young and old, make mistakes or listen to the wrong advice.
Remember, if you ever have any questions about a particular credit move, talk to someone who is experienced with it, like a financial advisor. It’s better to move slow and find the information that you need than make a mistake that will hurt you for years into the future.