Frugality isn’t a new concept. Some have been pinching pennies since there have been pennies to pinch. Although some level of thriftiness is a necessity for most households, some embrace a frugal lifestyle whether or not they have to.
Depending on your situation, a frugal outlook could translate into a useful tool for building credit. Let’s explore how you can potentially increase your credit score with an assist from your frugal tendencies.
Frugality is a polarizing money topic.
On one end of the spectrum, you have people who lean into the concept in a pretty hardcore way. Typically, those embracing a frugal way of life don’t spend too much on their lifestyle. In fact, they often actively look for ways to slash their spending in a variety of areas.
On the other end of the spectrum, some cannot stand the idea of frugality. When one conjures to mind the idea of people stretching their dollars so far that they miss out on some of the fun experiences that make life enjoyable, it’s easy to want to run for the hills.
But the reality is that being frugal often falls somewhere in between the extremes of living in the moment without regard for the cost and only eating rice and beans to keep grocery costs down. Ultimately, the core of frugality is an unwillingness to waste money and careful management of monetary resources.
Frugality in itself won’t help you build credit. However, the sound money management practices you build through frugality can translate into positive credit impacts.
Here’s a closer look at how frugal tendencies can help you build a better credit score.
The core principle of frugality is thriftiness.
If you have a tendency to keep your spending in check, that can definitely help you avoid taking on unnecessary debt.
For example, someone with a frugal lifestyle is unlikely to whip out their credit card for the latest gadget. With that, they can potentially avoid racking up credit card debt simply by limiting their purchases.
A hallmark of frugality is that you don’t want to pay more than you have to for a particular item. With that, embracing a frugal lifestyle will encourage you to avoid making interest payments on any of your purchases, since credit card interest payments add to the overall cost of the item.
With a frugal mindset, you’ll want to make your credit card payments on time to avoid unnecessary fees and interest. If you are looking to build credit, this tendency to avoid carrying a balance could help your credit score.
When you keep frugality at the core of your budget, you’ll likely build some extra breathing room into your budget. That’s because the savings can really add up when you start pinching pennies across every budgeting category.
Ultimately, the wiggle room in your budget can give you the flexibility you need to pay all of your bills on time. Without this mentality of saving, it’s all too easy for our expenses to overrun our budget.
A mentality of “waste not, want not” can help you build savings and reach other financial goals. But beyond reaching financial milestones, you can use the power of frugality to make building credit a priority.
Here’s a closer look at some of the strategies you can employ to leverage frugality into a better credit score.
An emergency fund is a very useful tool when it comes to protecting your credit. With this fund in place, you can dip into it to cover unexpected expenses. That’s a better option than whipping out your credit card to cover the cost.
The financial cushion provided by an emergency fund not only makes life comfortable but also offers a safety net for your credit score because you may be able to avoid missing payments or taking on debt out of necessity in an unexpected situation.
A mindset of frugality can help you build up an emergency fund. Without this mindset of using resources carefully to maximize savings, the task of building an emergency fund can be easier said than done. Even with a frugal mindset, it can take time and diligence to build a robust emergency fund.
If you are just getting started, an emergency fund of even just $500 can provide a small cushion to cover small emergencies. But most experts recommend tucking between three to six months’ worth of expenses into an emergency fund.
Importantly, your emergency fund should be based on your expenses instead of your income. It offers the cushion you’d need to survive financially even if you lost your job. For example, let’s say that you spend $3,000 per month. With that, you might choose to build an emergency fund between $9,000 to $18,000. But if you have a more unpredictable income stream, you might decide to boost your emergency fund to a full year’s worth of expenses.
One of the most notorious forms of high-interest debt is credit cards. Although credit cards often offer a way to easily pay for purchases, the sky-high interest rates attached to the line of credit can push things out of control quickly.
As your credit card balance rises, your credit utilization ratio will also rise. You can calculate your credit utilization ratio by dividing your credit card balance by your credit limit. For example, if you have a $1,000 credit card balance and a $2,000 line of credit, then your credit utilization ratio is 50%.
Your credit utilization ratio impacts your credit score. Typically, a lower credit utilization ratio positively impacts your credit score. In general, you should aim to keep your credit utilization ratio below 10%. If you have a higher credit utilization ratio, that could drag your credit score down.
There are two ways to lower your credit utilization ratio. You can either pay down revolving credit accounts or ask your credit card issuer for a higher credit limit. Sometimes they are willing to raise your line of credit based on a recent raise or other change in your financial situation.
With a frugal outlook, you may prioritize a low credit card balance to avoid potential fees. The action can translate into a credit score boost if your credit limit is relatively high.
High-interest debt is a drain on your finances. And those with a frugal nature likely won’t be able to stand paying extensive interest charges. After all, you likely have more practical plans for those interest dollars.
It’s possible to turn your frugality efforts towards resolving your high-interest debt once and for all. Not sure how to tackle debt? Most take advantage of the debt snowball or debt avalanche strategies.
Here’s a closer look at both:
Technically, the debt avalanche is more mathematically efficient. But the debt snowball is more popular because it involves more wins early in the process to energize your debt repayment efforts.
Although you might need to get creative on where you save, a frugal mindset can help you pay down your debts faster.
Payment history is the most important factor in your credit score. In fact, this metric accounts for 35% of your FICO score, which means making on-time payments is a big deal.
Frugality can help you keep your expenses low. Depending on your situation, this could translate into an easier opportunity to make on-time payments to your credit accounts.
If you are able to lower your expenses through frugality, make it a priority to pay your credit bills on time. Sometimes, it’s easy to forget a bill payment. If you are afraid that life will get in the way, then consider setting up automatic payments to avoid accidentally missing a deadline.
When you push your costs down with frugality, that leaves some wiggle room in your budget. Depending on your situation, you might decide to make credit-building a priority for those funds.
For example, breathing room in your budget could give you the confidence to sign up for a credit-builder loan. These unique loan products can help you build credit and savings at the same time.
With a credit-builder loan, you won’t get any of the loan funds upfront. The lender will expect you to start making loan payments right away, but they’ll deposit the loan principal amount into an earmarked account for you.
With every payment, the lender will report the activity to the credit bureaus. If you are making on-time payments, that means you’ll build a history of positive payments, which is a good thing for your credit score. But if you miss payments, the loan can actually hurt your credit score. That’s why you might not decide to sign up unless your frugal nature has built enough cushion into your budget.
At the end of a credit-builder loan, you’ll get access to the savings you’ve created. Plus, you might even see your credit score rise.
Frugality gives you the mindset you need to lower your expenses. Although saving money won’t directly impact your credit score, positive money management choices can help you make efficient credit-building choices. If you make building credit a priority, your frugal tendencies can help you along the way.