How to Live With No Debt and No Credit Score

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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 using credit.

Challenges of Living Without Credit

Not using credit means that you won't have a credit history, which means you will have a low credit score. That 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 will take 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 will be even more difficult to buy a home. A renter may be forced to pay more upfront to demonstrate that they are a safe tenant.

How to Spend Without a Credit Card

Here are some strategies for living in our increasingly cashless society without a credit card.

Day-to-Day Expenses

You can use cash or a debit card to pay for everyday expenses, such as groceries, entertainment, or meals out. Cash makes budgeting easy if you use the envelope method to separate it 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.

Monthly Bills

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.

Prepaid Cards

If you don’t have a checking account, you can use a prepaid debit card instead of a standard debit card. A prepaid cards is “loaded” with funds before you use it. 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 that 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.

Frozen Funds

Debit cards can be problematic when the card gets swiped before the exact amount of your spending is known. That typically happens when you rent a car or hotel room or 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 having 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 it, your card will be declined, and your checks will bounce. Keep an extra buffer of cash in your checking account 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 with 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 most 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 creditworthiness, because you'll lack a credit history.

Alternative Credit

You’ll have to get approved based on “alternative” factors instead of a traditional FICO credit score to get approved for a loan. That will limit 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 that is 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.

Income

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 will most likely need to see that your debt-to-income ratio is less than 43%, and lower is better. As someone who is living debt-free, you are spending less than 43% of your income on expenses, which will include your mortgage payment.

Reserves

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.

Stability

Lenders are looking for a sure thing, or at least as close to one as they can get. A long history of employment is helpful, because it suggests that 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 someone must review and evaluate all of the details. That is a serious disadvantage if you're buying in a quickly moving seller's market where demand is high. Get started on the process as soon as possible if you live in a hot market, and 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:

  • 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 balance every month. You have a 30-day grace period before interest costs are charged, so you might 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 important 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 you 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 will become much better.

Article Sources

  1. Consumer Financial Protection Bureau. "Check Your Credit."

  2. Consumer.gov. "Making a Budget."

  3. East Texas Professional Credit Union. "Preauthorization Holds—Frequently Asked Questions."

  4. U.S. Department of Housing and Urban Development. "Module 4: Manual Underwriting of the Borrower."

  5. Consumer Financial Protection Bureau. "How to Rebuild Your Credit."