How to Live With No Debt and No Credit Score

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Most people see debt as a necessary evil. The conventional wisdom is to use debt, but not go into a debt spiral. Still, it is possible to live — and thrive — without using debt or worrying about your credit scores. For some, there’s little choice in the matter: if you have bad credit, you’re at a disadvantage. Others simply hate the idea of borrowing, or their values can’t support borrowing money and paying interest.

The benefits of debt-free living are easy to understand, but if you stop playing the credit game, things are different. It's important to know what challenges you face and how to overcome them. Simply put, if you don’t borrow money and repay loans, you won’t have credit — or you won’t have high credit scores. As a result, it can be harder to buy things, and re-entering the world of credit scores can be painful if your plans change.

You don’t have to go back to the Stone Age if you decide to ditch debt. It’s easy to operate in modern society — and even to take advantage of technology — without relying on credit.

Saving More, Spending Less

One of the biggest challenges of the debt-free lifestyle is that you have to pay for everything with cash, although it doesn’t necessarily have to be paper cash — it can be a debit card. This may not be a problem for your daily spending and regular expenses.

You should be able to cover these out of your income anyway. Otherwise, your current situation is not sustainable. For larger things, however, this is more challenging.

You’ll have to save up a substantial amount of money to buy a vehicle without financing it, and it’s even harder to buy a home. If you’re not going to borrow, it takes more time, more savings or both to afford major purchases.

In other words, you’ll have to save for more months or find a way to put more dollars toward your goal each month. For most people, the preferred solution is to wait longer to buy and to buy less expensive things. That’s not a bad approach to take, but it’s not what you’ll see most of your friends and neighbors doing. You’ll have to be satisfied with the internal rewards of simpler living instead of the external rewards that most people seek.

How to Spend Without a Credit Card

  • Day-to-day expenses: For everyday spending — groceries, errands, entertainment, and meals — you can pay for things with cash or a debit card. Cash makes budgeting easy if you use the envelope method, but keeping cash around is risky. A debit card linked to your checking account gives you all the convenience of a credit card, but you’ll only spend money that you actually have.
  • Monthly bills: If you’ve grown accustomed to paying monthly bills such as your mobile phone, utilities and gym membership with a credit card, that’s an easy habit to break. Switch to online bill payments so your bank sends funds to your biller, either by check or by electronic transfer. Just like 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. 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 loaded balance. 
  • Debit vs. credit cards: Whether they're prepaid or not, debit 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 — you don’t have to pay the bill for another 30 days, which gives you time to clean everything up without getting your checking account involved.
  • Frozen funds: Debit cards can also 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 to begin with 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 rental agency will require that you use 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, you’ll need to work a little harder than most borrowers due to your lack of credit.

  • 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. This limits the number of lenders you’ll be able to work with, because some lenders prefer not to think outside the box. It also limits the types of loans available. 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.
  • 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 most likely need to see your debt-to-income ratio below 43 percent, and lower is better.
  • Reserves: It’s also helpful to have liquid cash reserves on hand — in other words, 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 it 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 can also be a factor — seasonal employment is less dependable, while a government job is often 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 — somebody must review and evaluate all the details. This is a serious disadvantage if you're buying in a seller's market, and it could be frustrating. 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, it’s worth knowing why you might want good credit so you can make a conscious decision to do without, with a full understanding of the pros and cons.

  • 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 the card off every month. You have a 30-day grace period before interest costs are charged. You’ll never pay a penny in interest, you’ll maintain your credit, and you’ll have the added safety of a credit card.
  • If you ever need money, it’s nice to have a solid credit history. Again, debt is only a problem if it hangs around for too long. You can keep a credit card open for emergencies — just don’t use it to buy more than you can afford. Living without debt is appealing, especially after you’ve seen hard times. But if you ever change your mind and want to borrow, you’ll have to start from scratch after you let your credit dry up entirely.
  • You can’t erase the past. Even if you go debt-free, your credit history still exists and it can continue to cause problems. Those 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.
  • Spending is the problem. Credit cards and easy loans can lure you into a debt trap. Bad luck and health problems can make things worse. But for some people, the problem is just a matter of spending more than they can afford. Leaving credit and debt behind can quickly get rid of temptation, but a harder and more important task is to understand where your money goes and why you’ve spent the way you have. Make a plan you can stick to and your chances of success become much better.