MoneyUnder30.com

Radically Re-Thinking Credit Cards: Part One


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.

Re-Think Your Credit Cards! from David Weliver on Vimeo.

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?”

Part Two: A New Way to Use Credit Cards

In Part Two of Radically Re-Thinking Credit Cards, I offer a new strategy for using the two credit cards you do keep minimally and responsibly (so the banks won’t cancel them). Read part two now »

Get access to our best money hacks:

Join over 11,000 other young professionals and learn how to get out of debt by 30, increase your income this year and invest for financial freedom.




100% free! I will NOT spam you and I will NOT share your email.

About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. This is exactly the conclusion we came to. We went to the bank to apply for a debt consolidation loan when we were trying to get our cards under control, but they would only do it at a relatively high interest rate, and only if we would commit to canceling a certain number of cards and/or reducing credit limits. I understand why, but we decided instead to do a transfer to a card with a temporary low rate and stop using multiple cards. Now almost everything goes on just one or two cards, so it’s easier to track. We still have the credit lines open, but we rarely use the other cards. We have almost paid off all our credit card debt too!

    I think the impact on our credit score of following the bank’s advice would have been pretty terrible. Firming up your self-discipline (or physically cutting up the cards you intend not to use, if discipline is a problem) without closing the accounts seems like a better plan.

  2. The one thing to keep in mind if one decides to go the “cut up or freeze” of credit cards strategy is that most card issuers will cancel a credit card with no warning if the cards havent been used for a while. It is best to use the cards to purchase a few small things here and there and just pay them off rather than not using them at all otherwise they could all be canceled without warning and your credit score would take a hit.

  3. David Weliver says:

    @Briana, thanks for sharing your story. Sounds like you watched the video and are onto part two. @Joel…hold up, part two tomorrow is gonna cover that. The strategy doesn’t say to just leave the two cards open and not use them. You’re gonna use ‘em, just in a very specific way.

  4. Honestly, I spend more with cash than I do with my credit card. I noticed this trend in myself years ago, and I’ve had other people tell me they feel that way as well. The way I understand it in myself is that money in my checking account is “bill” money – it’s there for paying my loans and my car insurance and my credit card bill (that I pay off monthly). So even when I spend with a credit card, I have an acute understanding of the fact that the money will be coming out of my “bill” money.

    But cash? I can’t pay my bills with cash! None of them will accept cash! So if there’s cash in my wallet, it always feels like fun money. I can’t keep more than a little cash in my wallet, or it will get spent on really frivolous things. I hardly ever buy anything frivolous with my credit card, though.

    I covered the studies that say you spend more with a credit card on my blog as well, but I came to different conclusions: http://poorerthanyou.com/2007/10/12/do-we-spend-more-when-we-use-swipe-plastic/

    So for me personally, I’m going to continue to use my credit card for everything, because that’s how I best control my own spending.

  5. David Weliver says:

    That’s a great insight, Stephanie; thanks. I can see why people treat cash that way (and hence feel they spend more cash than with credit).

    Personally, I know I fall for the “I don’t have to pay for this for another month” trap when I pay with credit. Even though I’m gonna pay the bill in full, I still find it easier to buy something with my credit card than I do with a debit card—if the money’s coming directly out of my checking, I *really* think about it in a way I don’t with credit.

    What I think people’s reactions to this article will show is that how we spend and use credit cards is very personal. I hope, however, that these two articles provide an alternative to many “all or nothing” strategies I’ve come across!

  6. I totally get the info in this post.

    Here is a brief synopsis of my sitch:

    We have no credit card debt. We have no temptation to use them, and have no problem setting them aside or using them responsibly. We choose not to use them for reasons that go beyond finances. We kept one card open, but we don’t use it either.

    Okay, you’re probably with me so far… but here is where I’m going to lose you:

    We don’t care about our FICO score.

    Lost you didn’t I? I know there are all kinds of reason why we should care… but… we don’t. I know only about 5% of people will understand this point of view. The other 95% do not need to list the 15 reasons why you need FICO… we already know them. We still don’t care. :-)

    I could go on about how we are never going to borrow money again, or how we don’t care about how FICO effects our insurance premiums… but the most concise explanation I can give in an already long blog comment is to say that it is a form of protest against an industry that we do not believe in.

    Ahhhh… deep breath Matt. :-)

    Good post David!

  7. David Weliver says:

    Well put, Matt.

    Basically, I wish I had the balls to not care about my credit!

    I’m hanging onto the fact that I’ll apply for a mortgage in a few years—I really hope not to borrow money for anything else.

    I don’t deny that credit scores are basically “I love debt” scores, and I think it’s crappy that we need to take all these weird steps to play into the system, but I guess, for now, I’m sucking it up and playing along.

    I commend you for taking such a gutsy stand!

  8. Thanks for the words of encouragement D.

    Some may think I’m crazy, some may think I’m an idiot, still others will think I’m awesome… I think I’m doing the right thing for my situation.

    Here’s the cool thing about not caring about our FICO: they’re still going to go up, or at least stay where they are. Here’s why:

    We have two mortgages on credit, two student loans on credit, and a Lending Club loan on credit. We repay all of them on time every month… always have, and Lord-willing… always will.

    So as I thumb my nose at the CC banks and their tangled and undesirable scoring system… I will retain and maybe even increase my score.

    I call that, “beautiful irony.”

  9. I am sick of people saying you spend more on cc’s. This may be true for some and not true for others. This is not a hard and fast rule. I didn’t have a cc my first two years of marriage and have now had one for about 2 years. Our spending has stayed the same. (We buy what we need.) and we make about 300.00 bucks a year for spending the money we had to spend anyway. I love it. the last two years it has paid for all our christmas presents.

  10. By the way, I have never carried a balance…ever.

  11. The way i see it, i love my discover card b/c of the cash back rewards. I have never carried a balance until they offered me a very low special rate. Still, i make a majority of the balance. What i have been able to do is keep the rewards that come in for using the card higher than the interest i pay for keeping a balance. If i keep that trend i am still ahead of the c/c companies.