How to Live With No Debt and No Credit Score
Many people see debt as a necessary evil, but it still is possible to live—and thrive—without using debt or worrying about your credit scores. The benefits of debt-free living are easy to understand, but it's important to know what challenges you'll face and how to overcome them if you stop playing the credit game.
Challenges of Living Without Credit
Not using credit means you won't have a credit history, giving you a low credit score. This can make it more difficult to buy things, and re-entering the world where credit scores matter can be painful if your plans change because it takes time to build a good one.
One of the biggest challenges of the debt-free lifestyle is paying for everything with cash. It doesn’t have to be paper cash; it can be a debit card. If you’re not going to borrow, it takes more time, more savings—or both—to afford major purchases.
You’ll have to save a substantial amount of money to buy a vehicle without financing it, and it’s even more difficult to buy a home. Renters may be forced to pay more upfront to demonstrate they are a safe bet.
How to Spend Without a Credit Card
Here are strategies for living in our increasingly cashless society without a credit card:
You can use cash or a debit card to pay everyday expenses—groceries, entertainment, meals, etc. Cash makes budgeting easy if you use the envelope method to separate your cash by purpose, but keeping cash around is risky. A debit card linked to your checking account offers the convenience of a credit card, and you’ll only spend money you actually have.
If you’ve grown accustomed to paying monthly bills such as your cell phone, utilities, or gym memberships with a credit card, that’s an easy habit to break. Switch to online bill payments so your bank sends funds to your biller by check or electronic transfer. Just as with a credit card, you can set things up so the payment goes automatically. Alternatively, you can pay these bills with your debit card.
If you don’t have a checking account, you can use a prepaid debit card instead of a standard debit card. Prepaid cards are “loaded” with funds before you use them, then you can swipe the card or make online bill payments out of your loaded balance. The card stops working after you use up your balance.
Debit Versus Credit Cards
Debit cards and prepaid cards are riskier for everyday spending than credit cards. If somebody steals your debit card number and racks up charges, those funds come directly out of your checking account. You are generally protected from fraud and errors, but you’ll have to notify your bank quickly for the best protection.
The real problem is that your account may temporarily get emptied, causing you to bounce payments, and this can result in a domino effect of messes to clean up. When your credit card number gets stolen, thieves spend the card issuer’s money, which gives you time to clean up everything without getting your checking account involved.
Debit cards also can be problematic when the card gets swiped before the exact amount of your spending is known. This typically happens when you rent a car or hotel room, or when you open a tab at a nightclub.
The merchant will pre-authorize your card and temporarily lock up funds in your checking account. These charges should fall off after a few days, but numerous charges combined with a checking account that’s running low can cause trouble.
You may have plenty of money, but if the bank won’t let you use your money, your card will be declined and checks will bounce. Keep an extra buffer of cash in checking to avoid problems, and check your available account balance regularly.
Debit Card Required
Debit cards work almost everywhere, even when an online form asks you to enter a credit card number. In rare cases, a car rental agency will require a credit card instead of a debit card to make a reservation. Find out ahead of time what cards are accepted or what the requirements are if you only have a debit card, especially if you need to rent a car.
Buying a Home
For some, the aversion to borrowing ends at buying a home. You can save up and pay cash for most things, but homes can cost hundreds of thousands of dollars, which would take decades of extreme saving for many buyers.
If you decide to get a mortgage and live a debt-free lifestyle, you’ll need to work harder than most borrowers to prove your worthiness because you lack a credit history.
You’ll have to get approved based on “alternative” factors instead of a traditional FICO credit score to get approved for a loan. This limits the number of lenders who will work with you and the types of loans available. It may also result in a higher interest rate.
You’re most likely to find a loan guaranteed by the U.S. government, such as an FHA loan. To determine your creditworthiness, lenders will look for information about regular on-time payments you make, such as rent, utilities, and insurance premiums. Make sure you pay on time for at least 12 months before you apply for a loan.
Another important factor is the income you have available to repay a mortgage loan. When doing manual underwriting—which is what you’ll need if you don’t have traditional credit—lenders most likely need to see your debt-to-income ratio is less than 43%, and lower is better. In the case of someone living debt-free, that means you are spending less than 43% of your income on expenses, which will include your mortgage payment.
It’s also helpful to have money in the bank. If you’re a debt-free saver, you're probably there already. The more financially secure you are, the more likely you are to get approved, even without a credit history.
Lenders are looking for a sure thing, or at least as close to it as they can get. A long history of employment is helpful because it suggests you will continue to earn a consistent income. The industry you work in also can be a factor. Seasonal employment is less dependable, while a government job often is considered secure.
Time to Close
Without traditional credit scores, it will take even longer than normal to get a loan. Manual underwriting is a labor-intensive process because somebody must review and evaluate all the details. This is a serious disadvantage if you're buying in a fast-moving seller's market where demand is high. Get started on the process as soon as possible if you live in a hot market, long before you make an offer.
Should You Abandon Credit Entirely?
Before you ditch debt for good, know why you might want good credit so you can make a more informed decision to do without:
- It doesn’t have to cost money to build credit and maintain great credit scores. You only pay interest when you borrow money. If you don’t have to borrow, use a credit card for everyday spending and pay off the card every month. You have a 30-day grace period before interest costs are charged, so you can never pay a penny in interest, maintain your credit, and have the added safety of a credit card.
- If you ever need money, it’s nice to have a solid credit history. You can keep a credit card open for emergencies—just don’t use it to buy more than you can afford.
- You can’t erase the past. Even if you go debt-free, your credit history still exists, and it can continue to cause problems. Debts will fall off your credit reports eventually, and collectors can't try to collect after the statute of limitations has run out, but that takes several years.
- A spending mismatch is the problem. Credit cards and easy loans can lure you into a debt trap. Bad luck and health problems can make things worse. The most important task is to understand where your money goes and why you’ve spent the way you have. Make a realistic plan and your chances of success become much better.
Consumer Financial Protection Bureau. "Check Your Credit." Accessed June 12, 2020.
Consumer.gov. "Making a Budget." Accessed June 12, 2020.
East Texas Professional Credit Union. "Preauthorization Holds—Frequently Asked Questions." Accessed June 12, 2020.
U.S. Department of Housing and Urban Development. "Module 4: Manual Underwriting of the Borrower." Accessed June 12, 2020.
Consumer Financial Protection Bureau. "How to Rebuild Your Credit." Accessed June 12, 2020.