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3 dubious credit card moves that seem smart

By Leslie McFadden · Bankrate.com
Thursday, June 24, 2010
Posted: 2 pm ET

On Monday, I wrote about 5 smart credit moves to make now. Today's post is all about what not to do. The following tips sound smart, but can backfire if followed with abandon.

1. Asking for a lower rate on your credit card. Starting Aug. 22, 2010, new rules will require issuers to review interest rate increases every six months and reduce the interest rate 45 days after the review "if appropriate." Of course, you can still ask for a lower rate at any time, but understand that issuers can check your credit and ask questions about your financial situation.

As John Ulzheimer, president of consumer education at Credit.com, explains in my article on whether to ask for a lower interest rate, "They may make an adverse change to your account because of what they see on your credit report or something that you've told them."

In other words, rejection is not the only negative outcome that could result. For example, you could see your credit limit lowered or your account closed based on information you give about your job or salary. At the very least, examine your credit record before making the call and have a back-up card. You can check your three credit reports for free, once every 12 months at AnnualCreditReport.com, and free credit scores at commercial websites such as Credit Karma and Quizzle.

2. Closing credit card accounts you're not using. It makes perfect sense to simplify your life by having fewer accounts, but your credit score won't reward you for reducing your access to credit.

It won't shorten your credit history right away, as some articles suggest. Closed accounts with perfect payment histories will sit on your credit report for up to 10 years. Where closed accounts can penalize the score is in the "amounts owed" category, which is worth about 30 percent of a FICO score. Your debt-to-credit limit ratio plays an important role in this category. The closure of an account with a zero balance reduces your available credit, which can raise your debt-to-limit ratio.

What to do: If you need to close an account but don't want to penalize your score, reduce the balances on other accounts. If you always pay in full, this means charging less on your other credit cards. Better yet, leave the account open and tuck the card away in a sock drawer.

3. Putting everything on your rewards credit cards. Sure, you can maximize your rewards points that way, but getting close to the limit can backfire, even if you pay the balance in full every month. Banks usually report the balance billed to you in your statement. If this amount is high in relation to the limit on the account, your debt-to-limit ratio could increase, which could hurt your credit score. A lower credit score could make it harder or more expensive to obtain loans, an apartment and even a new cell phone. It could also trigger credit limit reductions or an interest rate increase on new purchases.

What to do: Use your rewards cards, but don't overspend. In addition to the risk of getting into too much debt, a sudden surge in spending could trigger adverse actions on your account and reduce your credit score. A good rule of thumb: Use no more than 30 percent of your credit limit. Spend less than 10 percent if you want to maximize your score.

Know any other dubious credit moves?

Follow Leslie McFadden on Twitter.

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12 Comments
lizdlaidley
July 30, 2010 at 8:50 am

can anyone help me pull it together to buy a home?

lizdlaidley
July 30, 2010 at 8:43 am

My mortgage banker told me to not to use my mastercard just charge $1.00 per month and pay it off as soon as I used it. I did not listen to him but paid off monthly the balance of $250. This debulcal caused my score to drop 25-40 points which stopped me from purchasing a home. any suggestions to help me increase score?

Leslie McFadden
July 07, 2010 at 9:49 am

Alanna,
Great question! No, there isn't a scoring advantage to closing the account earlier. What matters to the score is that the account is closed, not who initiated the shut down. See my story about closing accounts and credit scores: http://www.bankrate.com/financing/credit-cards/closing-credit-card-affect-credit-score/.

Alanna
July 06, 2010 at 5:44 pm

Is there any difference in how a card closing is reported when you opt-out of a rate increase? I opted-out of an increase Citi proposed in fall 2008 that would have more than doubled my rate from 5.74% to 15.99% (I've never missed a payment or been late). When the card expires in Dec. 2010 the account will be closed, but I was wondering if there is any advantage to closing the account earlier than that. Meaning, will it be reported as closed by the consumer either way, or is one more positive / less negative than the other?

John Pachuta
July 02, 2010 at 4:59 pm

Cash is King! Cut up all your credit cards, pay off the balances, join a credit union for business, and tell the commercial banks to "Go Pound Sand - Your Credit Card is Completely Worthless".

Leslie McFadden
June 29, 2010 at 12:36 pm

Bjorn, just to clarify -- the suggestions from Credit.com's John Ulzheimer are examples of strategies that seem smart but are actually risky. His comment was in reply to my Twitter request for examples of such dubious credit card moves.

Bjorn
June 29, 2010 at 12:20 pm

Not a big fan of those suggestion from Credit.com. In times on high unemployment, 401k loans are risky in that you generally have to pay the balance at time of separation if you are laid off. Lots of people are being laid off. Furthermore, you're eating into your earning potential for the future, for your retirement. Thousands now over a few years can mean tens of thousands you're unwittingly forfeiting in the future. A better bet is to not get a huge loan and buy a more reasonable, if less flashy and/or prominent, vehicle.

Leslie McFadden
June 29, 2010 at 11:14 am

Debra, the strategy you mentioned can be a smart way to minimize one's debt-to-limit ratio and control spending.

You have to be organized for this strategy to work, though. If you pay before the closing date, and then receive a bill for the remaining balance, you still have to submit a payment. Failing to keep track of remaining balances could result in missed payments, which could then trigger late fees, a penalty interest rate and delinquencies on your credit report.

Debra James
June 28, 2010 at 10:45 pm

With regards to tip #3, I think an additional tip could have been to tell people that if they want to continue using their credit cards for most purchases to maximize the cash back/rewards, they should make mid-billing cycle payments on the balance due. That way they will see how much they are actually spending more frequently than just waiting until the bill arrives. The early payment may also reduce the opportunity for a good portion of the bill not getting paid due to the cash being used for something else. Also, the payment will reduce the amount that is reflected on the bill and reported to the credit bureaus, and the debt-ratio will not be so high.

Leslie McFadden
June 24, 2010 at 2:48 pm

John Ulzheimer, of Credit.com, left this comment on my Twitter feed on Linked In: "Close cards you're not using, take a 401K loan to pay off a truck loan to improve your score, Revolve a balance each month because it helps you build credit faster. Those are some gems."

That last one I've come across often. Folks, your score doesn't care if you pay interest or not. It's okay to pay in full. What matters is keeping statement balances low in relation to the credit limit.