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Living a "credit-free" life may sound appealing. If you are able to live within your means on a cash-based system, being credit-free has some perks, but it also has a downside as well. There are a few things you'll want to understand first, if you are thinking about making the transition.
Advantages of Being Credit-Free
One advantage of not having any credit-related accounts is that you do not have to pay interest or make payments toward that debt, freeing up your money, giving you greater discretionary spending ability. For example, the typical household credit card debt of $7,000 at a 15% interest rate costs over $1,000 per year in interest. If you are not carrying that debt, the $1,000 will be available for you to spend or save as you like.
Living credit-free also helps to prevent overspending. When you do not have credit, the decision of whether or not to buy something is not tied only to emotion, but also to how much money you have available in your wallet or your bank account.
In addition to the financial advantages, you also have emotional perks. Being in debt may cause stress and worry, especially if you are on a tight budget. Many people feel a sense of freedom when they live credit-free.
Disadvantages of Living Without Credit
The main disadvantage of living without credit is that you will not be building a credit report. Because your credit score is derived from data in your credit report, you will not have a score at all if you don't have a credit report. This may make it difficult if you ever decide to get credit to buy a car or house for example. Also, insurance companies and employers sometimes check credit scores as well, and you may run into difficulties with them if you do not have a score.
The other disadvantage of living without access to credit is that you would want to build up a significant savings account since you will not have the ability borrow on credit as a financial safety net. Sometimes it may be difficult to know how much money would need to have saved for large purchases or emergency situations.
Tips for Making a Credit-Free Life Work for You
- Build up an emergency fund of three to six months of basic living expenses. If you lose your job, you will not have credit cards to fall back on to make ends meet. Your emergency fund can also cover unexpected expenses, like car repairs. If you ever have to use money from the fund, replenish it as soon as you can.
- Use long-term budgeting strategies for major expenses. Think forward to your anticipated expenses in the coming year, like vacations, home repairs, or holiday gifts, and set money aside for these expenses every month. Use the same strategy to save up to buy your next car, or even a house.
- Consider keeping one credit card account open, but completely unused, if you feel it necessary to maintain a credit score. This open account will continue to appear on your credit report and generate a credit score for you. However, be aware that you may need make an occasional small purchase (and pay it off immediately) to keep the credit card issuer from closing the account due to inactivity.
- If you currently have credit and are looking to go "credit-free," work on getting out of debt as quickly as possible once you have made the decision to live credit-free. Stop buying anything on credit, and start making more than the minimum payments, focusing on paying off one account at a time. Then, close out the accounts once they are paid off so you aren't tempted to still make purchases on them.
