Friday, March 6, 2009

Credit Cards and Credit Scores: Setting the Record Straight

{{Potd/2008-03-06 (en)}}Image via Wikipedia

My whole adult life I've only had one credit card, a Visa, (unless you count the department store card I got for the promotion and used once). But I've just recently acquired two other cards, a Mastercard and an Amex. A friend and I were discussing credit cards the other day because she was rather miffed that a shop she went to didn't take Visa, the only card she had. That's why I have one of each.

"But isn't having that many credit cards bad for your credit score?"

Actually, the number of credit cards you have doesn't really matter. What does matter is the ratio of your used credit (debt) to your available credit. The lower the ratio, the better; it looks good if you're not maxing out your whole credit line. Getting another card can actually raise your credit score because it increases your available credit, thereby reducing your debt-to-available-credit ratio.

This is certainly not to say you should go apply for five more cards. In fact, applying for more than one credit card (or loan or other type of credit) every six months can hurt your score, so if you must acquire multiple cards, space them out.

Of course, one of the dangers of having lots of credit is that some people have a tendency to use more of it than they should, i.e. buy things they don't need just because they can. Another danger is simply keeping them all straight. Unless all your cards have exactly the same terms (and they won't), you're going to have to be very careful which cards you use for what. For instance, say Card #1 has 0% APR on purchases and no annual fee for the first year (but you've only got 2 months left of that); Card #2 has no annual fee ever, 13% APR, and a good rewards program; and Card #3 has 18% APR on purchases, no annual fee for the first year (which just started), and no fee 0% balance transfers. You could use Card #2 for all your regular purchases (in order to get max rewards), put big purchases that you can't pay off right away on Card #1, and then in 2 months transfer the balance from Card #1 to Card #3.

Great, but you better remember:
  1. to transfer the balance from Card #1 to Card #3 before it starts accruing interest

  2. not to put any purchases you can't completely pay off each cycle on Card #2

  3. not to put any purchases at all on Card #3*

  4. to call Card company #1 when the first year is up (in 2 months) and either A) ask for the annual fee to be waived and don't put anything on it you can't completely pay off each cycle, OR, failing that, B) close the account**

  5. not to transfer any balances to Cards #1 or #2

  6. that you'll be able to pay off Card #1's balance that you transferred to Card #3 when Card #3's first year is up OR that you'll definitely be able to get another card with fee-free 0% BTs

  7. to call Card company #3 when its first year is up and either A) ask for the annual fee to be waived and don't put anything on it you can't completely pay off each cycle, OR, failing that, B) close the account**

  8. Remember to pay all your bills--even when you have 0% APR, you still have to pay the minimum balance each month
*When you make a payment on a credit card, it always applies first to the balance with the lowest APR. This means that if you made purchases on and transferred a balance to Card #3, you can't pay off your purchase and then go on to pay the minimum payment on the transfer. You'll be stuck running up interest on your purchase until you've paid off the transfer.

**Now you don't want to close any credit card account you don't have to--it lowers your credit score every time you close a card. (Note: That said, you're better off closing a newer one than an older one. Maintaining an account for a long time boosts your score--you don't want to lose that.)

You definitely have to be organized to juggle several active credit cards, but depending on your situation it might be worth it. For instance, I've got a student loan that's going to start accumulating 6.8% interest in June, so I'm putting it on a 0% APR card: my monthly payments will be smaller and I'll avoid accumulating interest. (Remember, though, you should only do this if you know you can either pay off the remaining balance at the end of the introductory period or have another no-interest card you can put it on. Otherwise, you'll be stuck paying a way higher interest rate than 6.8%.) I'll continue to use my lower-limit Visa (at 16%) for regular purchases, and the remaining card is basically for keeping my ratio stable; the only thing I'll use it for is booking travel since it comes with an unusually good travel insurance plan.

How many credit cards do you have and how do you keep them organized? What do you use your cards for?

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Nicholas said...

Actually there is a limit to how many credit cards will help. For example, if you have 3 credit cards out there with no balances on them thisusually is a good thing. However, let's say your total available credit is $30,000 between the three cards. When I worked at a bank, this would cause a red flag, not a devastating one, but one that required more research. The reason lies in the fact that if the bank gives you a loan, you still may go out the next day and max out your cards, thereby throwing $30,000 extra on to your debt burden. Again, this isn't a huge deal but something that banks do look at. So the moral is don't keep getting credit cards just to increase your available credit.

Wren Caulfield said...

@Nicholas: Thanks for the input. The bank POV is good to consider. Like I said in the post, just because you *can* get multiple cards doesn't necessarily mean you *should*. I certainly don't advocate getting 10 cards just to increase your credit limit. That's pointless. Nevertheless, there's no set limit to the number of credit cards you can or should have since everyone's situation is different. If you're applying for a loan, the bank will consider your potential to default of course, but if you have a healthy credit history and haven't defaulted in the past, most likely they won't turn you down just because you have ample lines of unused credit. It all just depends on what you're trying to accomplish. Increasing my cards to 3 worked for me in raising my credit score and allowing me some flex room for my finances.

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