The majority of financial advice on credit cards falls into one of two categories:
- Credit cards are evil and you should cancel them and never, ever use them again.
- Credit cards are fantastically convenient when used responsibly and can actually make you hundreds a year in rewards.
Both are wrong.
Been burned by credit cards? It’s tempting to do what Matt did: Close ‘em, shred ‘em, and forget ‘em. If you’re either so mad at the card racket or think you can’t trust yourself with credit, then cancel ‘em. But before you do, consider this: Canceling credit cards makes it harder to maintain good credit. Hope to apply for a mortgage? (Or even an apartment?) You’ll want good credit.
Some money wizards recommend shredding your cards; others say “credit cards are greeeat!” After all, card rewards earn you a couple hundred extra bucks a year. Unfortunately, most rewards-seeking spenders will actually spend more money than they’ll earn in rewards using a rewards credit card. Let’s take a closer look at both of these fallacies.
Why You Shouldn’t Cancel All Of Your Credit Cards
Canceling all of your credit cards is tempting, especially if you’re sitting in loads of credit card debt and the cards are already maxed out anyway. Better to just get rid of them so you won’t use them again, right? While you’re digging out of credit card debt, you need to make sure you don’t go into any new debt. Solution? Eliminate your access to your credit cards. In this situation it’s a good idea to:
- Freeze your credit cards or
- Cut them up.
- Just don’t cancel them!
Canceling all of your cards is short-sighted. You do hope to be out of credit card debt eventually, right? And, hopefully, you plan to have learned a lesson and be in a better position to use credit cards responsibly (i.e., pay them in full every month). If that’s the case, you’ll want your credit cards open. But maybe not all of them. That’s why I’m going to recommend this: cancel all your credit cards but two. (After all, you really shouldn’t need more than two cards).
Which cards should you keep open?
- The card with you’ve had the longest.
- The card with the highest credit limit.
Why these two?
If you use credit cards the way I’ll suggest in part two, the interest rate won’t matter because you’ll never carry a balance. As for rewards, keep reading. You don’t need ‘em. Keeping your oldest credit card and the card with the highest limit, however, is best for your credit. Accounts that have been opened longer and accounts with higher credit limits, in general, equal a better credit score.
If you’re in so much debt your credit cards are maxed out, your credit score isn’t very good because your utilization ratio (how much debt you have versus your total available credit) is really high. But as you pay down your debt, your credit recovers. Canceling all of your credit cards will actually hurt your credit score even further, because you no longer have available credit and your utilization ratio will be over 100 percent until you’re totally out of debt. Once you’re debt-free, getting a new credit card may still be difficult for months or years to come. By canceling all but two of your cards, you’ll still have cards open available when you’re out of debt.
Let me add a disclaimer: If you know you can’t trust yourself with credit cards, then ignore this advice and do cancel your credit cards. Never use them again. But if you would like to learn to use these tools to your advantage—responsibly—keep reading.
So, why don’t I recommend you keep the card with the best rewards?
Why You Shouldn’t Chase Credit Card Rewards
Credit cards make you spend more. In The Illusion of Credit Card Rewards, Tough Money Love discusses this phenomenon, citing psychologists who found:
[Two studies] demonstrated that people are willing to spend (or pay) more when they use a credit card than when using cash. Importantly, the results of both studies suggest that the underlying reason for the differences in spending is, at least, partly due to differences in the pain of paying.
Note that these studies aren’t even looking at the rewards cards—just credit cards in general. When you add rewards into the mix, you actually have an additional incentive to spend more than you might ordinarily—you’re getting airline miles or cash back! Yippee! The bottom line? Credit cards are engineered to get you to spend too much. Even if you can pay the card every month, you still spend more than you would otherwise.
You can think that you’re smarter than everybody else and can still beat the system, but you’re only fooling yourself.
My conclusion is that it’s silly to chase credit card rewards. If your card offers them, great. You’ll earn some when you use the cards as I describe in Part Two. But never try to cram all of your monthly spending onto credit cards just because of the rewards. It’s a recipe for overspending.
For a case study of this strategy, please see “I have seven credit cards. Should I cancel any of them?”