Editorial Policy

Responsible Cash Use Won't Help Your Credit

Erica Sandberg

November 20, 2012

QDear Erica,

I haven’t had a credit card in years, nor have I made any purchases on credit. I usually pay cash for small and large purchases. Why is that not good for my credit? Why does your credit score change when an inquiry is made on you? And, finally, does it hurt your credit to apply for credit cards? — Abram

ADear Abram,

There is a very good reason that spending with the dollars in your wallet or bank account will not help you establish a credit history: You’re not using credit.

Now, I have no beef with cold, hard cash. I love it for many things and circumstances. However, a credit report is a record of your borrowing and repaying activity, not how well you manage dollar bills.Ask Erica

It works like this:

If you were to get a credit card or take out a loan, the lender would immediately begin sending the three credit reporting companies — TransUnion, Equifax and Experian — details about that account. Your reports will list such data as the date you got it, the amount you borrowed (or can borrow, if it’s a credit card), what your current balance is and your payment patterns.

All this information is very important to lenders, other businesses and individuals who want to know what kind of credit manager you are. By paying on time and keeping balances low on a variety of accounts for many years, your credit report will look all kinds of wonderful. It shows long-term responsibility. Such an impressive past is an indicator of an equally great future. That means you could be more eligible for low-rate loans, less expensive insurance products, tenancy in a tough rental market —  and even a good job if the company checks reports.

If you’ve just been using cash, no one will know how brilliant you are or could be with money.

Now, this is not to say that what you might have in savings isn’t significant. It is, and not only to you. For example, if you’d like to borrow money to buy a car, the lender would also take into account how much of a down payment you can afford. Your assets would be a crucial factor in securing excellent financing.

OK, now for the inquiries. Every time you apply for a credit card or loan, an inquiry is added to your reports. Credit scores are generated from the data on your reports, including those inquiries. A company like FICO takes what’s being listed and translates it into a score that others can use to assess lending and business risk.

Some information is factored in to a score much more heavily than other information. And inquiries are comparatively minor. If you’re asking yourself why they matter at all, consider this: If it’s evident that you’re applying for loans all over town, you look desperate for money. It could indicate a problem, which heightens your risk level. So that should answer your final question — if you apply for a card, you might see a small, temporary drop in your credit scores. Yet, unless you start applying for cards like crazy, that ding should be short-lived. All you have to do is keep inquiries to a minimum and only seek the products you need and qualify for, and you’ll be fine.

Also, keep in mind that not all inquiries are equal. “Hard” inquiries (a credit check that occurs after you apply for credit) are visible to lenders and affect your credit scores. “Soft” inquiries (when you check your own credit, or when a credit card company pre-approves you for a card) remain invisible to lenders and don’t affect your credit.

My best advice is to continue to use cash smartly, but also to get a credit card. It’s the best way to pay for items online, especially if you want to book a flight or reserve a hotel room. It’s also ideal for expensive things and services, because credit cards offer built-in consumer protection. After building an excellent credit history, you can eventually get a rewards card, too, which enables you to build points for cash back or for other goodies.

Make sense? I hope so!

Got a question for Erica? Send her an email.