Zeroing Out Debt
Does it Harm Your Credit Score?
By Daniel Muniz

Contrary to common sense, smart debt management can lead to negative consequences to your credit score. Wise management of your debt may put more money in your pocket but it will hurt your credit score if you do not already have a long established credit history, like 15 years or longer.

Sound confusing?

Part of the confusion is because there is a stark difference between debt management and credit management. The two are not the same and the goals of both strategies are totally different and often are at conflict with each other.

And as ironic as this may sound, your debt is actually the source of your good credit.

However, in past generations, your grandparents and great-grandparents probably viewed debt almost as if it was pure evil. Or at least debt was something to be avoided or paid off as soon as possible. And today, there are still plenty of people who view debt with deep suspicion and mistrust. There is some merit to that mistrust especially with predatory lending practices from sleazy financial institutions.

But unlike the modern culture of today, the past was a cash-based society with limited access to credit and even when it was available, credit terms was severely restricted. Even all the way up to the past couple of decades, credit was still greatly limited to customers with spectacular credit ratings and credentials. And the credit granting process a generation ago was also rife with enormous discrimination such as redlining.

Fast forward to today. An 18 year old college student with no work history or even income can apply for a national bank credit card like Chase or Citibank and get approved with a substantial credit limit.

No doubt times have changed and the ease of credit has led to catastrophic consequences for a number of people.

But debt doesn't have to be a bad thing.

Properly managed, you can become a prime or super-prime customer with the ability to obtain the best financing terms and the lowest interest rates available. And the results are obvious. The less money you pay in interest, the more money you can keep in your pocket, hence the best reason to have the highest credit score possible.

But the only way to attain an excellent score is by having long credit histories with responsible credit behavior. A credit score is simply the result of a statistical model. The more positive data you to put into it, the better your credit score can be. The less good data this model has to interpret, the fewer opportunities you have to raise your score.

Think of a credit score as job experience. The more experience you have in a particular field or skill set, the more marketable you are. If you have zero job experience, the harder it is to find that good paying job. However, the only way to get experience is that you have to start somewhere and usually that means starting at the bottom.

The same goes with your credit score. Lenders want to see that you have the long-term experience and the capability to be responsible with debt before they risk loaning you money. The less risk, the better the financing terms a lender is willing to offer. The less experience you have with managing your debt, the greater the risk, thus the higher interest rate or you may be denied a loan.

Consequently, the people who have the best credit scores are often middle-aged and older consumers who happened to have paid off a mortgage and a number of car notes as well as having credit cards from the same issuer since the beginning of time.

So with a limited credit history, the worst thing you can do is cut the life of an installment loan in half or close a revolving account. The only way you can build good credit is by exercising responsible credit behavior by keeping those contractual obligations open.

The choices seem grim but if you are a consumer with a limited credit background then you must choose the path of credit management instead of "smart" debt management.

I know it seems "wrong" but the only way to obtain the best financing terms for your future and possibly for your lifetime is to continue to demonstrate responsible behavior with long credit histories. Or at least do so until you reach the upper echelons of your credit score.

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