How Debt Is Good for Your Credit Score

Getting out of debt is important, right? But the idea that you should have no debt can be misleading, especially when it comes to your credit score.

If you've just won the lottery and never have to borrow money for something like a mortgage, then you may not need a credit score. But for the rest of us, a high credit score leads to better interest rates and borrowing opportunities.

The way to get a higher credit score is by borrowing and managing your debt well. In fact, a credit score is simply a history of your debt management practices.

If you have no debt, then you have limited credit history and likely a low credit score. In fact, many retirees are surprised when they learn their credit score has dropped after retiring with their house and cars paid off. To maintain a high credit score, there are the top three "rules" to follow:

1. Keep your credit card usage low and keep your accounts open for the long haul. By having a lower than 30% credit utilization rate on your cards (but not zero), and paying those cards on time for many years, you demonstrate consistent debt/credit management, resulting in a bump on that portion of the scoring algorithm. If you don't use your credit cards for purchases, at least consider using them to pay your utility bills, then pay the card balance off each month.

2. All debt is not the same when it comes to the credit score algorithm. Having only one type of debt affects your score. The ideal credit mix is a blend of two types: installment loans (mortgage and car) and revolving credit (credit cards, store credit).

3. You don't need a perfect score to score great interest rates. While an 800 score sounds nice, most lenders will give you the same rates if your score is "merely" in the mid-700's, often 720 and 740 being the cut off point for better rates.