You walk into the department store and see the sweater. Yes, the sweater. Featured on the cover of the winter catalog, it draws you with all its cream-colored woolly glory.
Then you see the sign. The delicious sign that says if you open a department store credit card today, you can save 20% on any purchase.
This is your lucky day. Or is it?
The “Doh!” Moment
You buy the sweater, and it’s everything you dreamed it would be.
The problem is that you forget that you charged it. Your credit card bill comes in the mail, but you accidently recycle it. The bill goes unpaid.
The next month, you visit your mortgage broker to refinance. He informs you that your credit score dropped because of a past-due department store credit card account. Your reduced credit score resulted in a .25% interest rate hike on your $250,000 mortgage. That’s $36.32 every month for 30 years, or $13,075 to be exact.
Credit card offers can be enticing. From free airline miles to 5% savings storewide every day, they are hard to resist. But you have to make sure you have a strategy in place to make at least the minimum payment, on time, each month.
Missing just one payment can wreak havoc on your credit score and raise your borrowing costs for all other credit-related purchases.
Even if you have to write the due dates on your forehead, it’s worth the embarrassment to remember to pay credit cards on time. If you’re disorganized, it’s a good idea to use only one or two cards, and request both paper and emailed statements. The more reminders, the lower your chances of missing a payment.
Credit Card Oxymoron
Although making your credit card payment on time is of utmost importance, that’s only the beginning when it comes to good behavior with credit cards. It sounds oxymoronic, but credit bureaus can penalize you for using your credit cards.
Your credit score goes down when your utilization ratio is too high. Your utilization ratio is the amount you have charged on open-ended credit accounts compared to your overall available limit.
Although official percentages are not published by credit bureaus, experts believe that you should limit your total credit card balances to 30% of your limit across all credit cards, and preferably less. So if you have two credit cards with a combined limit of $5,000, have less than $1500 charged on them at any one time.
Mo’ Credit, Mo’ Problems? Not necessarily.
It would seem that closing credit card accounts would help your credit score. After all, the fewer credit cards available to you, the less trouble you can get in, right?
According to credit bureau giant Experian, credit card holders who close their accounts may actually be hurting their credit scores. It all goes back to your utilization ratio. By closing accounts, you are cutting your overall available credit, thereby increasing your percentage of outstanding debt.
For instance, if you have five credit cards with $10,000 limits on each, your overall limit is $50,000. If your balance total is $5,000, your utilization ratio is only 10%. But if you close four of the cards, suddenly your utilization ratio is 50%. Your credit score just took a big hit.
Older and Wiser
There’s another downside to closing credit cards. Credit bureaus look at the age of your accounts. A long history on credit accounts with no derogatory history leads to better credit scores. When you close a credit card, you lose that longevity.
The best strategy to maintain and improve your credit score is to leave unused credit card accounts open. Leave the cards at home so you’re not tempted to use them.
If your utilization ratio is too high, first and foremost try to pay down your credit cards. This will save you money paid in interest and lower your utilization ratio. In addition, call your credit card company and ask them to raise your limit. Often, they will, and you will reduce your overall percentage of amount borrowed.
When More Credit Hurts
Using that same logic might prompt someone to open lots of new credit cards. But there’s yet another piece to the puzzle.
Credit bureaus can see when you apply for credit. A lot of new credit applications all at once can signal that the individual will run up lots of new debt and not be able to repay it. Is this individual about to lose his job or file for bankruptcy? Is he preparing for some other personal financial disaster? The credit bureaus have no way to know, so they assume the worst.
If you do open new credit cards, open them one at a time. Over time these accounts will be beneficial to your credit score if you use them correctly. There’s simply no overnight way to improve your credit score with new credit card accounts.
Credit cards can be powerful tools to build credit, earn rewards, and put a safety net in place for unforeseen financial events. But the downsides can be painful. If you use credit cards wisely, you can avoid common mishaps that kill your credit score and cost you a mint.