The latest episode of the Money Girl podcast was inspired by an email I received from Dave K. in New York. He says:
“I know you generally recommend against closing credit cards so your average credit age isn’t adversely affected. However, is there a downside to opening a credit card to take advantage of a promotion (such as getting $200 for spending $1,000 in the first 90 days) and then closing it a few months later? It seems that strategy would preserve my credit age.
Also, is my credit score negatively affected by having too many credit cards, even if they’re all in good standing? If so, how many cards are too many?”
Thanks for the great questions, Dave! I love that you’re watching your credit and thinking through those significant financial decisions.
Building and maintaining excellent credit is one of the best ways to improve your financial life. It allows you to save money on various products and services—such as credit cards, lines of credit, car loans, mortgages, and auto and home insurance (in most states)—and qualify for promotional offers and low or no security deposits on utility accounts.
I’ll cover ways your credit cards help you build credit and bring more value to your financial life. As we review them, I’ll be sure to answer Dave’s questions. Here we go!
The first way to get more value from credit cards is by building a positive payment history.
A common misconception about credit is that if you have no credit cards or loans that you must have excellent credit. That’s false because having no credit is the same as having poor credit. To have good credit, you must have credit accounts and use them to show a history of responsible use.
Now, I didn’t say you have to go into debt to have good credit. However, if you have an installment loan, like a mortgage or an auto loan, paying it on time certainly boosts your scores.
However, the great thing about revolving accounts, such as credit cards and bank lines of credit, is that they allow you to quickly build credit without taking on debt. One strategy is to make monthly small card charges that you pay off in full.
Even if you only make a card’s minimum payment, you get the same credit benefit as if you paid off the entire balance. But, of course, I recommend paying your total card balance each month so you avoid interest charges and use your card for free!
The second way you get value from cards is by having more available credit.
With revolving accounts, the more available credit you have, the better your credit score. Dave mentioned that closing a card reduces your average age of credit. And while that eventually happens, a more critical issue is that canceling a card spikes your utilization ratio immediately.
Your credit utilization ratio compares your debt to your available credit limit on revolving accounts. When you cancel a card, your utilization ratio significantly increases because you have the same amount of debt and less available credit.
So, like it or not, closing a card makes you appear less credit-worthy, and your credit scores plummet. Also, note that opening a new account is a hard inquiry that does temporarily ding your scores.
That’s most detrimental to your finances when you plan to finance a big purchase, such as a home or car. Jeopardizing your credit could ruin your ability to get a competitive interest rate and cause you to overpay interest for decades. But if you’re not going to take out a loan soon, closing a credit card may not be a concern.
A third way to get more value is by having multiple credit cards.
There’s a common misconception that it’s okay to max out a credit card if you pay it off each month. While that’s a wise way to avoid interest charges, it doesn’t guarantee a low utilization ratio.
That’s because the date your card account balance gets reported to the national credit agencies isn’t the same as your statement due date. So, if your balance happens to be high on the date it’s reported, you’ll have a high utilization ratio that drags down your credit scores.
A good rule is to keep your utilization ratio below 20%. For example, if you have a $1,000 card balance and a $5,000 credit limit, you have a 20% credit utilization ratio ($1,000 / $5,000 = 0.2 = 20%). But what if you need to charge more than $1,000 per month?
One solution is to spread out charges on multiple cards instead of consistently maxing out one. Another strategy is requesting credit limit increases on one or more of your cards. Having the same amount of debt compared to more available credit reduces your utilization and improves your credit.
Dave also asked if his credit score is negatively affected by having too many credit cards, even when they’re in good standing. As I mentioned, having more open revolving credit accounts makes you more likely to have higher credit scores—when you manage them responsibly. And if you regularly bump up against a 20% utilization ratio, you likely need an additional card.
Theoretically, there’s no limit to the number of cards you can or should have. If you manage them responsibly, you’ll be helping, not hurting your credit.
I recommend that you have at least two cards so you have a backup if something goes wrong with one of them. And have as many as you believe benefits your financial life and are comfortable managing.
A fourth way to get more value from cards is by using rewards strategically.
Consider how different credit cards can help you achieve financial goals, such as saving money on everyday purchases you’re already making. Many retailers, big box stores, and brands have cards that reward your loyalty with discounts, promotions, and additional services.
I use multiple cards based on their benefits and rewards. For instance, I use my Prime Rewards card exclusively on Amazon to get 5% cashback. I have a new Chase Instacart card that I use just for deliveries from that app that also pays 5% cashback. And I have a card with no foreign transaction fees when traveling overseas.
Periodically review your everyday purchases and where you spend the most, such as groceries, gas, or travel, and use cards that pay you the best rewards.
The fifth way to get more from cards is by keeping them active.
Credit card companies are in business to make a profit. If you don’t use a card for an extended period, they can close your account or even cut your credit limit. You may not mind having a card canceled if you haven’t been using it, but as I mentioned, a cut in your credit limit means a danger to your credit scores.
So, keep your cards open and active, especially if you might apply for a significant loan in the next few months. You might charge something small and pay it off a few times a year, such as once a quarter, to stay active and keep your available credit limit in place.
The sixth way to get more from cards is to close them strategically.
If you’re determined to cancel one or more cards, space them out over time, such as by at least six months.
Don’t be afraid to cancel if you have a card you don’t like because it charges an annual fee or a high APR. Just replace it with another card before you cancel the first one. That allows you to swap out one credit limit for another and avoid a significant increase in your credit utilization ratio.
Before closing a card, ask yourself the following:
- Will I need to apply for credit soon? I don’t recommend closing a credit card if you plan to buy a home or finance a vehicle in the next 6 to 12 months. If your utilization ratio increases and your credit scores dive, you could end up overpaying for interest.
- What’s the card’s credit limit? The lower a card’s available credit, the less it could harm your credit when canceled.
- How long have I owned the card? One credit scoring factor is the average length of time you’ve had accounts in your name. So, it’s better to keep a card you’ve owned for years than a card you recently opened.
Also, never keep a card that tempts you to overspend or make impulse purchases. Taking a temporary hit to your credit might be well worth it in the long run to prevent more significant problems in your financial life.