Maintain Good Credit While Living on Cash: 4 Tips

Last Updated Dec 30, 2010 3:42 PM EST

Christopher, a reader, wrote to me about a month ago, wondering how to reign in his spending and save. I suggested he stick to cash for a couple of weeks, nix the credit cards and see how it goes. According to his latest update, it's going fabulous. Using cash has limited his spending and he's managed to end up with some extra dough at the end of each week. He's so excited, he's thinking about giving up credit cards - forever. He's thinking of joining the band wagon of 8 million Americans who gave up credit cards this year.

On the one hand, if Christopher never needs a car loan, a mortgage or a small business loan, he may not have to worry much about his credit report. But that's not realistic. Most of us will need a line of credit - at some point - to afford life's big purchases. While I'm an advocate of using cash, we still live in a credit-driven world where your credit score and credit report can make or break your ability to access credit at affordable rates. How to strike a balance of saving money through the use of cash and maintaining good credit? Here are 4 pointers:
1. Don't close your accounts.

Christopher's impulse is to close all his credit card accounts so he won't be tempted to use them. But closing a credit line reduces the amount of credit in your name. It also reduces the "types" of credit in your name. Both of these are critical variables in calculating your credit score, according to FICO, the main credit score issuer.

2. Keep accounts active "enough."
It's not enough to just keep your credit accounts open. You need to use your credit cards in order to prevent the card companies from shutting them off for "inactivity." My advice: charge a small amount to each card each month, say $25 to $50. Let that amount be for things you need, not impulse purchases. Maybe automatically link a credit card account to a regular monthly bill, like your cell phone or cable bill, so you don't even need to really carry the card in your wallet.

3. Pay on time.
Before I get accused of pushing people to use their credit cards, I want to say it's equally important that you pay off the balance each month in full. For those credit lines that are linked to monthly bills, pay them off in full each month by hooking up a checking or savings account to that credit line. Schedule to have it paid off every month. Paying your credit card on time accounts for 35% of your credit score -- the biggest variable.

4. Check your credit report regularly.
To maintain good credit, you need to be in the know. Download a free copy of your credit report from each of the three major credit reporting agencies -- Transunion, Equifax and Experian. You have the ability to download these three reports each year for free. Just visit AnnualCreditReport.com.

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    Farnoosh Torabi is a personal finance journalist and commentator. She is the author of the new book Psych Yourself Rich, Get the Mindset and Discipline You Need to Build Your Financial Life. Follow her at www.farnoosh.tv and on Twitter at @farnoosh.

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