It’s not always the smartest move to use cash instead of your credit cards.
What you don’t know about credit cards can hurt you. So read on for smart ideas to help get the numbers going your way.
1. Use your credit cards.
Paying in cash and rarely using credit cards may be a point of pride for you, but it isn’t a good move for your credit score. As a result of the credit crisis, companies that once would have left inactive accounts open and tried to lure you back are now quick to close “sock drawer” cards. “Inactive accounts are unprofitable for credit-card companies,” says Liz Pulliam Weston, the author of Your Credit Score (FT Press, $19, amazon.com) and a personal-finance columnist for MSN Money. “Now it’s use it or lose it.”
While you may not mind losing a seldom-used card, there’s more serious fallout: Because 30 percent of your score is based on your debt-to-credit-limit ratio―the gap between what you owe on all credit cards and your total available credit―having one account closed increases that ratio and thus lowers your score. So use your cards, says Weston: “Regular, responsible use will help to maintain and improve your score.”
If your card is canceled for nonuse, it’s difficult to get your account reopened. You can try by placing a call to the credit-card company and highlighting your stellar payment history, says Sheri L. Stuart, education manager for Springboard Nonprofit Consumer Credit Management, in Riverside, California. But you will have to go through the application process again.
2. Pay off the lowest-balance credit card first.
If you’re feeling overwhelmed by credit-card debt, you may find it hard to stay motivated to keep up a serious repayment effort. While paying off the highest-interest card first will save you the most money in the end, the boost you get from quickly knocking off the lowest-balance card may be more instrumental in keeping you on track. Instead of spreading your monthly payments equally among credit cards, “snowball” your debt, advises Lisa Ray, a financial-education specialist at the Consumer Credit Counseling Service of Greater Atlanta.
With this method, you pay down the lowest-balance card first and pay minimum balances on the rest; as each card is paid off, apply the money you would have paid on it to the next-lowest-balance card, and so on. (If you also have other debt, Ray suggests starting with credit cards before moving to secured debt, like car loans and mortgages.)
3. Pay annual fees on a rewards card.
There are plenty of rewards cards out there that don’t charge annual fees, but paying one can make sense. In the end, a card with a fee and good benefits that suit your lifestyle may save you much more than a no-fee card you’ll use less. In weighing a card’s merits, try to project which benefits you’re more likely to use in a year. If the rewards (free hotel nights, discounted movie tickets, cash back into your child’s college savings account) total more than the card’s annual cost―and more than what you would save with a no-fee card―it’s worth the expense.
4. Don’t open retail-card accounts.
Why: Twenty percent off a new pair of jeans isn’t worth the potential damage that opening a store card can do to your credit score. First, five points are deducted for each new retail or gas card. Second, you’re lowering the average age of your credit history. Third, these cards tend to have lower limits and higher interest rates―sometimes 20 percent or more. Finally, running up balances on low-limit store cards affects your credit score more negatively than does using one or two bank cards, since bank cards’ higher credit limits increase your debt-to-credit-limit ratio.
5. Don’t pay off credit-card debt with a secured loan.
Why: Doing so may seem like a good idea, since the interest rate can be lower and you can consolidate your debts and make just one monthly payment instead of monitoring several cards. But by rolling credit-card balances into a home-equity loan, you are essentially converting unsecured debt into secured debt, says Ray. You’ll be putting your house up as collateral for the new television set or laptop that you charged. And if you can’t make your payments for any reason, debt collectors can seize your property.