We've all been there: After finally paying off a credit card balance, you want to vindicate your hard work by cutting the card in two and closing the account. It makes sense. Why keep a card around that may tempt us to spend more than we'd like again?
While cutting up credit cards might make us feel more on top of our finances, it's not necessarily therapeutic for your credit score. Even cards that you don't use anymore and carry sky-high interest rates can help your credit score. And here's why:
The more history you have as a borrower, the better your credit score should be. (Your credit score is a three-digit number, which the three main credit bureaus calculate based on your past payment history, that lenders and creditors use to determine whether you'll pay them back on time.) Even though you may no longer use the credit card you opened in college, closing the account entirely could negatively affect your profile as a borrower. Closing your oldest accounts makes you look like a newer borrower, says Wayne Sanford, a credit expert in Dallas and author of "The Real World on Credit."
Credit scores are determined, in part, by your debt-to-credit ratio. Make no mistake, paying down your credit cards is a good thing, but closing the account entirely could possibly lower your score.
Say, for instance, you have two cards with a $1,000 limit on each card. If one card has a $500 balance and you just paid the other card down to zero, your debt-to-credit ratio is 25% because you hold a $500 balance out of $2,000 possible credit. If you close the paid-off account, your ratio will spike to 50 percent because you'll have eliminated $1,000 of possible credit.
"I once had a client who wanted to close down a retailer retail credit card because it had a 43 percent interest rate," Sanford says. "She was trying to do the right thing by closing it, but it would have had a negative affect on her score."
Rather than taking the scissors to your credit card, consider using it to meet your monthly budgeting goals—and rack up rewards points in the process. One way is to use a credit card consistently for "everyday spending" such as groceries, gas and other routine expenses. Then, avoid interest payments by paying off the balance each month.
Russ Ferguson, an attorney in Charlotte, N.C., uses credit cards as often as possible because they allow him to accumulate rewards.
"To use cash is to throw money away," he says. "The points you get for every credit card purchase are worth real money and they add up quickly."
But Ferguson cautions: It's important to be meticulous about how much money you're spending, so you don't exceed your budget. Still, the time spent tracking, he says, is well worth the payoff.
"I have a card that gives me five-times points at restaurants and a different one that gives me five-times points at gas stations and grocery stores. I choose which card to use based on what I am purchasing."
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