Why Credit Should Be Used Regularly

Question: My mother pays for most large purchases with cash. She wrote checks to buy three cars in the last year — two luxury cars and a sport utility vehicle — yet according to lenders, she has bad credit.

Why do people like her, who use credit cards only for emergencies and then pay them off at the end of the month, get penalized when they want to buy something big like a house?

Answer: Your mother may not have bad credit. What she may have is a credit history that’s too thin to generate the three-digit credit score that most lenders use to judge a person’s creditworthiness.

The FICO scoring formula requires a consumer to have at least one account on her credit report that’s been open a minimum of six months and at least one account to be updated in the previous six months.

This requirement can make it tough for young people and immigrants to establish credit, because many lenders won’t open an account if the applicant’s credit history is too thin to generate a credit score.

But, as you’ve seen, the requirement also can hamper the well-off who choose not to use credit regularly. Paying for everything with cash might be smart for them financially, but they may find themselves unable to get loans at decent rates when they need to borrow.

The fix for this problem is fairly simple: Your mom would just need to use her credit cards more regularly. She doesn’t have to carry a balance; the FICO credit scoring formula doesn’t distinguish between balances that are paid off and those that are carried month to month.

All she would have to do is make a few small charges each month and pay them off promptly. She should avoid “maxing out” her cards or even using more than about 30% of her credit limit, and she should pay the bill on time. She could even put this on automatic, by having some regular expense such as a newspaper subscription charged to her card and then authorizing the payment directly from her checking account.