How to get your credit score up, and how not to care

Every Tuesday is Finance & Family Day at Zen Habits.

Reader Jay Dolan asked about credit scores:

Do you have any resources, or info on how to get my credit score up? I went to apply for a car loan and found that my credit score was too low, even for approval at a credit union. It’s getting a bit frustrating because I have some money to put down on a used car, and I have figured out using pear (thanks for that link) that I can afford about a $500/month car payment. I am not looking to spend that much on it, but if I cant get approved for a loan what should I do?

This is a complicated question for me — my answer will really have two parts: 1) how to improve your credit score; and 2) how to make that unimportant to you.

How to improve your credit score
Basically, the way to improve your credit score is to show that you can reliably pay back your debts. To do that, you need to build a good credit history over time — take out small to medium sized debts and pay them back over time (not all at once — show you can do it over a long period of time). Here are some tips:

Check your credit report. You can get a free credit report once a year from annualcreditreport.com. This will allow you to see if there are any mistakes, and to get an idea of where you’re at. They won’t give you your credit score, but you can at least see what’s on there. If there are errors, take steps to correct them.
Establish credit accounts. Personal loans or credit cards are usually the best ways to do this. Don’t take out a bunch of junky store credit cards. Take out a few cards that you can keep for a long time. Getting cards with high limits but keeping the balance low is best.
Pay your bills on time. This is obvious, but late payments will hurt your score big time. Don’t be late.
Don’t close out old accounts. If you have cards that you’ve held for a long time, keep them under your name, even if you don’t use them. Accounts with long standing are good for your score. Closing accounts hurts your score.
Get your parents to help. If you’re young and just starting out, you face the Catch-22 situation of not having enough credit history to get loans or credit cards. But you can’t establish that history until you do get them. The answer is to get your parents (or someone with good credit history) to co-sign for you. Make sure your name is on the loan, and be sure that you pay it on time. Once you’ve done that, you have a history. Another solution, if you’re a parent, is to take out a loan with your son or daughter’s name on it, and pay for it yourself. This way you know that it’s being paid on time, so you don’t risk your own credit score, but your child is also getting a positive credit history. Update: A reader pointed out that opening a loan in someone else’s name is illegal … what I meant here is that you could co-sign on a loan with them, with their consent, and pay it back for them to build up their credit. Don’t do it without their knowledge.

Some articles with more depth on this issue:

How Not to Care About Your Credit Score
Now, having said all that, I have to say that I disagree with the above tips. That is to say, if you want to improve your credit score, those tips will help — but I think you shouldn’t do them.

Why not? Because, for many people, credit is dangerous. Sure, if you’re good at paying your bills on time and you aren’t tempted to spend money when you don’t have it, you’ll probably be fine. But then you probably won’t need this article. For the rest of us, credit cards can be a path to financial ruin. It’s one of the biggest causes of financial problems in the U.S.

So what do I propose instead? In short:

Avoid credit. Instead of taking out credit cards or loans for the sake of improving your score, avoid them like the plague. Taking out credit for the sake of improving your chances of taking out more credit seems like insanity to me. Instead, save until you have enough money to buy something. This takes patience and a bunch of penny-pinching at first. For example, I just sold my car to pay off my car loan, and got a cheap used van to replace it. I’ll be able to pay off the van quickly, and my goal is to then save my money so I can buy my next vehicle with cash.
Pay off your debts and cancel your accounts. If you have a lot of debts, pay them off, despite the advice in the section above. Use the debt snowball method.
Use cash instead. I canceled my credit cards and now pay cash (or make online payments) for everything. It’s convenient, you can’t get into debt or financial trouble, and it makes you think twice about spending it when you physically see it dwindling. See How I Ended My Affair With the Credit Card for more.
Relax with debt-free bliss. When your debts are all paid off, and you use cash instead, and can pay for your car in cash … well, there’s no feeling like it. It’s incredible.

Will this approach work for everyone? No. Many people need credit, and for those who can handle it, credit can be a good tool if used carefully. Others need to use credit cards a lot for hotels or rental cars, and using cash for these things can be less convenient. But it works for me, and I recommend that you give it some thought.

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How to get your credit score up, and how not to care