Please Try again!
Why Habits That Create Good Credit Can Still Be Bad For Your Finances
personal finance

Why Habits That Create Good Credit Can Still Be Bad For Your Finances

Kristin Wong, Gawker Media

Photo by Sutha Kamal

You know credit matters, and you've even learned some tricks for boosting your score . One final lesson everyone should learn about credit, though, is that what's good for your credit score isn't always good for your financial health. Credit can sometimes be counterintuitive to good money habits.

Like it or not, credit matters . It's also complicated. In our "Everything You Need to Know About Credit" series, we're breaking down the basics.

Advertisement

For example, if you never use credit at all and stay away from debt completely, your finances are presumably in decent shape. Debt is rarely a good thing: it frequently leads to a downward spiral of more debt or a cycle of living paycheck to paycheck. Thus, you'd think staying away from it completely would be good for you altogether, right? Not when it comes to credit.

Establishing Credit History Means Using Credit

Without opening a card or taking out a loan, you'll have a hard time establishing credit in the first place and, like it or not, we need credit not just to get a mortgage or a car loan, but for non-credit-related things, too. Landlords look at your credit when you apply for an apartment, for example, and so do some employers. And bill providers are legally allowed to charge more for customers with "risky" credit. If you don't have credit at all, they might consider you a risk.

Advertisement

This is why many experts recommend opening a credit card and paying it in full every month (contrary to popular belief, revolving a credit card balance does not help your credit, though). Just remember: not being in debt is more important than a good credit score. Contrary to what many "credit building" sites will tell you, though, you don't need to open 20 different cards to build a healthy credit history. In fact, there are some options for building credit without opening a bunch of credit cards:

If you're opening a card for your college-age kid to help them establish credit, you could even hold onto the card so they're not tempted to use it.

Credit Utilization Means You're Rewarded for Higher Limits

Thirty percent of your FICO score is determined by something called credit utilization. This is the amount of credit you have available to you versus the amount you actually use. Ideally, you want lots of available credit that you don't actually use. The problem with this is you might be tempted to use it!

Advertisement

Thanks to credit utilization , questionable financial moves like opening a bunch of credit cards at once can actually boost your score. And closing old cards can cause your credit score to drop, not only because of credit utilization but also because of your history with that card. So if you've paid off an old card and don't want to be tempted to use it (a smart money move) your credit could take a hit if you close.

Paying off a loan can sometimes cause your score to drop, too! As Credit.com explains , this is unique, but it does happen. None of this is to say you should open a ridiculous amount of cards or keep cards open just for the hell of it (especially if you're paying a fee) or not pay off a loan, of course. Your score is just a number. It's an important one, but keep in mind, it's your credit report and history that really matter. And if your credit report shows a solid history of paying your debt in full and on time, that's what will impress lenders, landlords, and the like.

Advertisement

Still, there are responsible ways to make credit utilization work for you. You could keep an old card open and put it away so you're not tempted to use it. If you already have a card you don't use, you could call the issuer and ask for a higher limit. Just make sure to keep track of any accounts you have open.

Settling Old Debts

You'd think debt settlement would help your credit. Rather than just ignore your overwhelming debt, you agree to at least pay something . That should help your score, right? Not always.

Advertisement

When you settle a debt, you usually work with a third party company who buys the original debt at a discount and then gets you to pay a portion of it to make a profit. In the best case scenario, this company will agree to mark your old account "paid as agreed," which yes, is good for your credit.

However, while they might do this as a courtesy, they're not required to do so. Credit expert Todd Ossenfort explains how settling a past debt can make your score even worse :

When you settle a debt for less than is owed, your credit history will take a severe beating... if you are current on your accounts now, settling your debt will make your credit history much, much worse. The reason is because a creditor is only willing to settle a debt for less than the full amount owed, when they believe collecting part of the debt is better than collecting nothing at all. When you are current with payments, the creditor has no reason to believe they will not be able to collect the full amount, and they are very unlikely to consider settling your account.

On the other hand, if your debt is already more than 90 days late, Ossenfort says settlement probably won't make your score much worse.

Advertisement

Credit can be confusing because we typically think of a credit score as a way to gauge financial health. It's not, though. Your credit score estimates how well you handle credit, not how you handle debt or savings. For that reason, it doesn't always go hand in hand with good money habits.

Contribute to LifeHacker

Write for Us

Subscribe for latest stories