"Living debt free" is a nice slogan, and beyond that it's something we should all aspire to. Unfortunately, some people couple this concept with living credit free. That is a far different story.
For most people credit still represents something that happens to us, rather than something we can build, nurture, manage and protect like an investment portfolio.
A lot of folks simply don't like the idea of credit or the fact that banks and other organizations collect information about us in order to determine whether or not we are worthy borrowers. It feels unfair -- like they are having conversations behind our backs, and when they make mistakes, it can be difficult to fix the problems.
Nevertheless, credit and the evolving system that shapes it -- whether it's the creation of new credit scoring models or the changing standards of lending institutions -- can either stifle or advance economic growth and is (for better or worse) a reality in our lives. While it is not impossible to live without a credit score, the unforeseen consequences of doing so can have a real impact, particularly for people in a crisis.
Consider these instances where having a credit history can enhance our lives:
1. You're not ready to buy, so renting is your only option.
If you're just starting out, or have chosen to immunize yourself from credit and don't have a credit score (or a credit file so thin you are impossible to score), your options are limited. Dreams of owning a home may well be premature or unrealistic. Your only play will be the rental market.Many landlords check potential tenants' credit reports and scores before renting out an apartment. The practice is especially common for recent college graduates and young adults, whose incomes rarely equal 40 to 50 times the monthly rent, as some landlords require. Therefore, you may well have to:
- Put down a gargantuan cash deposit (perhaps 3-12 months).
- Find one or more roommates (whom you may or may not like).
- Convince a friend or family member with a fair amount of spare credit or assets to co-sign for you.
- Enroll in a rental guarantee program like Insurent, which charges between 75 percent and 110 percent of a month's rent. In New York City, where the average rent is $2,902 a month, that could cost you as much as $3,192. The average rent nationwide is $804 per month, which means a deposit program (if you could find one that covers rentals in your area) could cost the average renter an extra $884. Another company, RentSecure, blocks out enough money on your credit card to cover a half-year's rent. In Los Angeles, where the average monthly rent is $1,389, that could load your credit card account down with $8,334 in unusable credit, which then can't be used to buy necessities or cover emergencies. However, if you're a "cash-only" true believer you may not have a credit card, which means this option is not available to you anyway.
2. You're in a financial crunch.
If you lose your job, get hit with a huge medical bill, or suffer another financial emergency you can't immediately afford, with a solid credit score you have options. Maybe you get a home equity line of credit, or put some of the bill on a credit card? At current fixed rates and depending on your score, the first option would about 6.25 percent in annual interest; the second would cost about 13 percent. There is the possibility that a hospital will work out a payment plan with you, though that could come with an interest rate, and not everyone will work with you. If you don't have access to affordable credit when an emergency strikes, then the only alternative is expensive credit. Consider a car title loan, in which a company gives you money up-front in exchange for the title to your car. Such loans come with an average annual interest rate of 300 percent, according to a recent study by the Center for Responsible Lending. One in six people who obtain a title loan come to face repossession of their cars. Then there's the infamous payday loan. The average APR on a payday loan is 417 percent. These are often the only options for people with poor credit.
3. You want to take a vacation, rent a car or are dying to see the latest Bruce Willis movie.
Try booking a hotel reservation, or renting a car or even a video without a credit card. It's very difficult and may well require a large deposit, or a significant "block" on your debit card, tying up precious cash in your bank account.
4. You need to find a job.
Millions of Americans are unemployed and looking for work. Like it or not, some employers are asking job applicants to permit them access to their credit reports. Although a number of states have enacted laws that limit employer access to credit reports, it is an emerging trend that cannot be ignored.
5. You're tired of making money for everybody else.
Unless you were born in the right bed, have friends with money who love your concept, have made prudent investments in the past few years, or capture the imagination of the right venture capitalist, it will be extremely difficult to leave your job and start your own business if you don't have credit. Further, a strong credit profile enables you to pay less for access to money leaving more disposable income to invest.
What to Do If You Need to Build Credit
No doubt, many people use credit like a 17-year-old, borrowing to the max and not worrying about the consequences. It's also possible to drive a car like a 17-year-old, flooring it all over town and occasionally ramming into people, but that doesn't mean no one should buy a car.
In adult hands, treated like an asset rather than a vehicle for irresponsible behavior, credit can be a powerful life enhancement and wealth building tool.
An auto loan can help us better afford a reliable car to drive to a better-paying job. A mortgage enables homeownership, which for most Americans has been the cornerstone of wealth and long-term financial stability. When paid promptly every month, credit cards can make it easier to track spending, earn rewards (even get cash back), build a more solid credit profile and help smooth out the ebbs and flows of income and expenses during times when cash is tight and running a balance is unavoidable.
Every one of these life events, each representing another financial building block, is made more possible when you have a solid credit report and a good score. Building a strong credit history requires constant maintenance and attention lest it become a rap sheet and not a resume. (If you're not sure where your credit stands, you can use Credit.com's free Credit Report Card for a clear breakdown of the information in your credit reports, as well as your credit scores.)
Building good credit also requires that you spend responsibly; that you don't use credit cards like money because they're not money. Golden Rule: If the cash isn't there to pay for what you've charged, you'd best think twice before swiping. Our friend and cash-only guru Dave Ramsey is dead right about that, and many other things, but even he acknowledges that sometimes "life happens." Fact: Not everyone has a five figure emergency fund, and for many people access to affordable credit is the difference between financial struggles and financial ruin.
Managing credit indeed requires hard work, but the payoff can lead to a richer and fuller life on a number of levels; pretending it doesn't exist limits our options.
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