Jenelle wrote in recently and described her way of using credit cards:

Unlike your advice to minimize your credit cards, I actually have eight open credit cards that I use all the time. These cards cover all of my purchases but each one has a particular bonus program that I can take specific advantage of. Twice a month, I just log onto the online service for each card and pay each one off in full.

In essence, Janelle is describing having a portfolio of credit cards, enabling you to use the one with a very high reward benefit with every purchase. In some ways, this plan does make a lot of sense, but there are some severe drawbacks as well. The trick is finding a routine that works for you. Let’s take a closer look.

My Would-Be “Credit Card Portfolio”
In order to figure out what this situation would look like for me, I went through all of my spending over the last month and figured out several general areas of spending, mostly based on where I spent the money. From there, I started looking for credit cards that specifically lined up with those areas.

Gas expenses (21% of spending) could be shaved big time if I focused exclusively on one gas station. For instance, the BP Card earns 5% cash back on all purchases at BP, so if you use that as your exclusive station, you’ve got an immediate 5% rebate on all of you gas spending.

Other automotive expenses (5% of spending) could be covered by the Discover Open Road card, which gives a 5% cash back bonus on all automotive expenses.

Online shopping (21% of spending) allows you to use something like the Amazon.com Visa, which gives you 3% in rebates for all purchases at Amazon.com, which works well for us since we buy bulk items there, among other things.

Department store shopping (14% of spending) almost always offers a decent rewards card for in-store shopping. Since we mostly shop at Target (a Super Target is the nearest department store to us), we can get a card there that gives us a 10% off coupon for an entire shopping trip for every $500 run through the card. If you shop there spending $100 every trip, saving up big purchases to spend $300 when you have a 10% off coupon (saving $30), that means you save $30 on every $500 in purchases, or about 6% back.

Grocery store shopping (29% of spending) and other purchases (11% of spending) would perhaps best be covered by the American Express Blue Cash card, which offers 1% cash back up to $6,500 worth of spending, then 5% cash back on all purchases after that. If you spent $12,000 on the card in a year (by running some of your bills through it, for example, and doing all of your grocery store shopping with it), for instance, you’d wind up with an effective rate of about 3% over the course of a year.

So let’s say I spent $1,500 a month through these cards at the percentages described. On the gas card, I would spend $315 and earn $15.75 in cash rebates. On the other automotive card, I’d spend $75 and earn $3.75 cash back. On the Amazon Visa, I’d spend $315 and earn $9.45 in rebates. With the Target Visa, I’d spend $210 and get $12.60 back. On the remaining card, I’d spend $600 and earn $18 back. All told, my returns would be $56.55 over that month on spending of $1,500 - that’s approaching a 4% return on the spending. For my life, at least, it would work pretty well, at least at first glance.

Dangers and Drawbacks
As with anything involving credit cards, there are a lot of dangers and drawbacks to this plan. As I said before when commenting on the credit card “holy wars”:

look at credit cards as being like a very dangerous power tool. If you’re careful and take the proper precautions, they can save you time and shower some rewards on you as well. On the other hand, if you use credit cards with reckless abandon, you run the serious risk of some intense financial damage to yourself.

Using this “credit card portfolio” idea amplifies the above statement. A 4% return across all of your spending is nice, but it’s fraught with complications and potential traps.

There’s more maintenance effort. Having several cards with active balances on them means more footwork. As Jenelle described, she puts in significant time just maintaining the cards, going through a session twice a month where she logs onto eight different online accounts. Not only that, you then have eight accounts sending you all sorts of stuff in the mail - and you do get stuff, even if you opt out. Even if this whole process only added up to an hour each month, it’d still only net me a little bit more than the straight 3% I get from my current card use - is that extra hour of online busywork worth $14 or so? It isn’t for me.

There’s a greater risk of identity theft. Using this plan means you have more open lines of credit, which means a slightly increased risk of identity theft. If you have several cards, after all, it’s easier to lose one and not notice it for a while. If you have several numbers out there, it’s easier for one of them to be nabbed.

One mistake undoes the benefits. If you’re late even once on just one of these cards, you’ll undo the benefits you gained. In other words, to excel beyond just using one or two cards, you have to be eternally vigilant.

Having a lot of credit cards can make it psychologically easier to buy unnecessary stuff. “But I can get 4% cash back if I buy it” is not a reason that should be ringing through your head when considering a purchase. Instead, ask yourself whether the purchase is really worthwhile at all - ignore any “benefit” from the card.

Having a lot of credit cards with low balances and high credit limits can be bad for your credit score. Sure, your debt-to-credit ratio is low, but 10% of your credit score involves the types of credit you have access to and use, and having a lot of revolving credit is not a good thing.

Overall, there are too many drawbacks to such a plan to make it worthwhile for me. I’m not going to invest the time or energy to do that much card-hopping and account maintenance to just get an extra percent back on my purchases. I’ll stick with my original simple plan, I think.

One of the most frequent negative comments I get on The Simple Dollar relates to credit card usage. I often advocate using credit cards for their purchasing convenience and rewards points, then paying off the whole balance each month. In effect, this means that I use a credit card as an extension of my checking account, albeit one that earns rewards for me. Over the course of the last six months using this strategy, I’ve earned about $500 in car rebates using my Citi Driver’s Edge card - and I’m carrying no balance at all. That $500 will go toward the purchase of a new car in the future.

So what’s wrong with that? There’s a rather vocal group of people out there who basically state that credit cards are completely unnecessary, some even going so far as to decry them as evil. Take this recent comment from Kerry on my article about a financial recovery toolkit:

You mentioned that you put your credit cards in your top dresser drawer and then over time were able to put them back in your wallet. Why not destroy them completely and close the accounts?

If you cannot pay cash for something, then you do not need it.

Along these same lines, individuals like Dave Ramsey and blogs like No Credit Needed follow that same philosophy: no credit cards, period.

And then there’s the other group… Part of the reason that the anti-credit card group is so fervently opposed to credit cards is because it is incredibly easy to lose track of the connection between plastic and real money, and when that connection is lost, it’s incredibly easy to get into a dangerous debt situation.

It’s for this reason that so many people are in deep credit card debt. Check out this article by Liz Pulliam Weston cracking the numbers on average credit card debt nationwide. The average American has $9,300 in credit card debt and the median American has $2,200. What these numbers mean together is that half of all Americans have more than $2,200 on their credit cards - and some of those have a lot more than $2,200. According to the article, 8.3% of households owe $9,000 or more on their cards, but many of those households owe way more than $9,000.

There’s clearly a problem out there with credit cards. A large subset of people out there treat them as if they’re free money, charging up balances that are going to be difficult to pay off. I routinely hear from readers with $30,0000 to $40,000 in credit card debt - and I myself had well into the five figures in credit card debt once upon a time.

So what’s the real answer? I look at credit cards as being like a very dangerous power tool. If you’re careful and take the proper precautions, they can save you time and shower some rewards on you as well. On the other hand, if you use credit cards with reckless abandon, you run the serious risk of some intense financial damage to yourself.

Here’s my advice. If you’re in a bad financial situation, get rid of your credit cards. Lock them up somewhere where you can’t get at them and don’t use them for a long while. However, if your finances are under control and you’re in good shape, the convenience, consumer protection, and bonus rewards offered by credit cards make them a worthwhile tool.

I strongly invite differing perspectives in the comments here, as I know quite well there are people who have come to different conclusions on the subject.

On a fairly regular basis, I suggest to my readers that they cancel unused credit cards except for their oldest one. In fact, I often suggest that you reduce your credit cards to one or two that you use for regular purchases and your oldest one - cancel the rest. This advice is often criticized, so I thought it’d be fair to dig into the issue in some detail.

The “Facts”?

Many people who disagree with this advice point out that one of the elements of a person’s credit score is the debt-to-credit ratio. In other words, the more cards you have, the higher your total credit limit is, and thus your debt-to-credit ratio is better.

From that perspective alone, then it is a bad idea to cancel your cards. But that pulls just one fact out of a big handful of facts. Let’s look at some more.

No one knows for sure how FICO (or other credit scores) work. As I stated in an earlier writeup about credit reports, FICO’s exact formula is a trade secret. They reveal “tips” on how to improve your score and have offered this as general guidance on what makes up your score:

35%,- punctuality of payment in the past (only includes payments later than 30 days past due)
30% - the amount of debt, expressed as the ratio of current revolving debt (credit card balances, etc.) to total available revolving credit (credit limits)
15% - length of credit history
10% - types of credit used (installment, revolving, consumer finance)
10% - recent search for credit and/or amount of credit obtained recently

What do each of those mean? It’s not clear - the best we can do is try to interpret them.

The types of credit used is a factor. If you have a lot of credit cards, you have a lot of sources of revolving credit, the worst kind. That hurts the portion of your score that evaluates the types of credit you’re holding.

Anecdotally, manual underwriters for home loans do not like to see lots of credit cards. When I applied for my home loan, I had two open credit cards - my oldest one and a general use one. The manual underwriter flat-out told me that such a status was a good thing because it showed consumer willpower and less risk that I’d be opening a lot of lines of credit. We ended up getting a very good rate on our home loan.

The more open credit cards you have, the greater the chance of identity theft. Identity theft is a serious concern, and the more open credit card numbers you have floating around at banks, the more likely you are to get bitten by an accident at a bank or unethical use of business records. While this is a small risk, if it does happen, it can be devastating.

A lot of available credit is a psychological temptation. It becomes much easier to just push the plastic and buy something if you have $15,000 in available credit on your cards. If you find it very easy to put purchases on your credit card and worry about the bills later, this is a real concern.

What Does This All Mean?

In a nutshell, it means that there is no definitive and clear answer about what to do. Since the exact formula for credit scores isn’t known, we have to make some guesses about what to do to maximize our credit scores while, at the same time, balancing our other risks.

If your primary goal is to raise your credit score by a few points, you’re probably better off leaving your cards alone for the time being. It keeps your debt-to-credit ratio in a good place, for starters.

However, if you’re a compulsive spender or you’re looking at getting a manually underwritten home loan soon, you should get rid of the extra cards, as other aspects present a greater risk to you.

By default, the best thing you can do is to only have a few cards to begin with and, most importantly, don’t put a lot of money on the cards. That way, your credit-to-debt ratio is good and you don’t have a lot of sources of revolving credit and you don’t have a lot of credit numbers sitting out there, either. Because of that, when people begin paying off their cards and getting into good financial shape, I believe it makes sense to gradually cancel your unused cards.

I often get notes from people who have a small mountain of credit cards. They’re trying to figure out which ones they should keep and which ones they should cancel for various reasons, and they’re (rightfully) concerned with their credit report when they do this.

Obviously, a wallet full of credit cards can be a problem: you have many more opportunities for identity theft and, often, with so many credit cards, your total line of credit may be high enough that it’s actually hurting your credit report. This doesn’t even cover the more aesthetic issues: extra paper management, an unreasonably fat wallet, etc.

So, if you have a mountain of cards, what should you do to trim them down? Here’s my recommendation for anyone dealing with a big pile of the cards.

First, identify one to be your primary spending card. There is no universal “best card” for everyone. You should look at your spending very carefully and choose one that best matches your habits. For us, we use the Citi Driver’s Edge card because we both commute for work and we earn a penny per mile driven in the form of a rebate on our next car purchase. It works well for us, but not necessarily as well for others. I actually have a second primary use card - we keep an Amazon card because we do a lot of our shopping there and it nets us 3% back on all purchases there, so we use the Amazon card exclusively for Amazon and the Driver’s Edge card for everything else.

Next, determine which card you’ve had for the longest period of time. Which is your oldest card? That card is the one that has the longest credit history, which is important for your credit report. For me, my oldest card is one that I got as a freshman in college. It has an atrocious “bonus” program associated to it (1/4% return in the form of “points”), but it was the first one I had and thus it’s been on my credit report for more than a decade, establishing that I’ve had positive credit for a long while.

Also, stop carrying this big, fat wallet full of cards with you. I only carry my two primary use cards with me. My oldest card is in my safe. All of the other cards I’ve ever had have been cancelled. This means my wallet is pretty thin, as I basically carry just a very small number of club and buyer rewards cards (library, Sam’s Club, Borders, Best Buy, etc.).

Then, start zero-balancing and cancelling all of your other cards over time. You can pretty safely cancel all of the rest of your cards that already have a zero balance. With the others, stop using them and start paying them off, making minimum payments on all of them and extra payments on whichever one charges the highest interest rate. When that one’s done, cancel it and start making extra payments on the next one and so on until they’re all gone, then cancel them.

What you’ll end up with is a much thinner wallet and a credit report in very healthy shape. The length of your credit history will remain unchanged and the ratio of your credit limit to your income will actually be in better shape than before.

This post is part of The One Hour Project, in which you can spend just one hour to put your finances in a better place without a big lifestyle change, through frugality or other financial choices.

This is something that’s well worth doing if you have consistently carried a credit card balance in the past and have never requested a rate reduction. It takes a bit of time (about an hour for a small pile of cards), but it can really save you some serious money in the long run. It’s pretty easy, too, as long as you’re willing to be a bit forceful over the telephone.

First, get out every credit card you have on which you have carried a balance in the last year. By “carry a balance” I mean you’ve not paid it off entirely and let the balance carry forward, earning interest. If you haven’t carried a balance in a while, the chance that they’ll reduce your rate is much lower because you’re not a client that makes them money.

Once you have these credit cards in hand, flip them over and call the phone number on the back. Punch whatever buttons you need to push to get to a human representative, then ask to speak to a supervisor. Most first-level people you speak to on the phone have no authority to raise your rate, so you must speak to a supervisor. If they won’t let you, tell them you are considering cancelling your card.

When you have a supervisor on the phone, request the rate reduction. Most of the time, they’ll just go ahead and reduce your rate; if not, tell them that you are considering transferring your balance (of course, this assumes you’re carrying one) to another card offering a 0% interest rate - this will often get the company to reduce your rate. If even this doesn’t work, suggest that you are having difficulty making the payments, which will often convince them. If these three tactics don’t work, politely say thank you and hang up.

Then, rinse and repeat for your other cards. Likely, the majority of these cards will wind up with some kind of rate reduction, and every one of these reductions will end up saving you money. Let’s say you have a card with a $2,000 balance that’s currently at 18.9% and you get the rate reduced to 12.9% - that’s a savings of $120 over the course of a year just from one phone call. With the average American credit card carrying household having a balance approaching $10,000, such an effort for an hour can save a lot of cash over the long haul.

I am constantly amazed at the creativity of companies that offer credit cards. They use a wide diversity of tactics to appeal to people and convince them to either start using a credit card or use a credit card more than they actually would. Why? The more you use a card, the more likely you are to carry a balance on the card, and the more likely it is that the credit card company will make a mint off of you. Here are seven of my favorite tactics that card companies use to cloud the issue.

Appealing to your social conscience. This is my current favorite tactic, with my favorite example being the American Express Red card. Available in the UK, the American Express Red card donates 1% of your spending to Global Fund, a charity created to fight against AIDS. Even better: if you spend more than 4,000 pounds on the card, that percentage goes up to 1.25%. Why, the more you spend, the more you’re helping the world! Right? Right? Many local banks mimic the same deal: here’s a local credit card from the Albina Community Bank of Portland, Oregon, that “gives back” 1% of all spending on the card to local charities. Such thoughts make it easier for many to use the card, as they think, “If I use my plastic, Timmy’s playground will be that much better…” then the bill comes, the minimum payment is made, and the credit card issuer cleans up on the interest.

Advertising some spectacular “benefits” up front. When a credit card offer comes in the mail, the 0.0% number is the one that sticks in the head. “It’s free money!” some will think. Well, that 0.0% is often only for balance transfers and only for a short time - aside from that, the interest is well in the teens. Even better, the companies couple this with user agreements that consist of dozens of pages of small text, something most people won’t bother to read. Which is no big deal, really, considering that part of each of these agreements is a statement that the card issuer can change the rules at will.

Mixing with your desire to spend time with your family. Remember that old family board game, The Game of Life? I certainly do, but I don’t remember the newest addition to the game: Visa cards. That’s right - a classic board game has been “updated” to brand with the Visa logo. Whip out your credit cards so you can go on vacation, kids!

Distributing a lot of “points” that don’t provide strong merchandise choices. Many credit cards, including the well-promoted Chase Freedom card, offer a program that affords you points, which you can then exchange for a wide variety of items. Well, more like “wide variety” - many points programs are rather limited on the items you can get. “Redeem your points for gift cards/certificates, hotel stays, car rentals, travel on any airline with no blackout dates, or merchandise” says the offer, but the selection is often very arbitrary or the price of the item costs such an exorbitant amount of points that you had to have burnt through many, many thousands of dollars on your card to get it.

Conspiring with youth culture. What seven year old girl wouldn’t want a Hello Kitty Platinum Visa card (yes, I realize that Hello Kitty has something of a wider market than that). Even the executives at Sanrio, the company offering the card, admit that the card is targeting pre-teen girls. Hopefully, parents out there have some sense about allowing an eleven year old girl to have a credit card, but with the average American household with one or more credit cards holding down roughly $9K in credit card debt, I worry about it.

Trying to tap into your spirituality and politics. The Enlightenment Visa is a points-based credit card that directly targets … well, environmentalists and Buddhists. The rewards catalog for this card features some impressively overpriced and focuses entirely on tchotchkes of direct appeal to what I often describe as the SUV environmentalist crowd or, perhaps more commonly, metrospiritualists. I have no problem with someone who authentically subscribes to such a spiritual worldview, but it seems to me that such a worldview shouldn’t be expressed through use of a Visa card. Yet it apparently has appeal to people seeking out a “socially conscious” credit card.

Leveraging your status as a fan of an entertainer or sports team. Such cards are designed to draw in “super fans” who must have everything with their favorite entertainer or sports logo on it. Take the KISS credit card, with a nice 32.99% interest rate the first time you are late on a payment, or the NFL Extra Points card which can include your favorite team’s logo, a 1% points program for overpriced NFL merchandise, and, if you dig into the fine print, a 29.99% APR if you’re a day late on a payment. I would brush this off if I hadn’t seen both of them in use in the past month or so.

What’s the best thing you can do as a consumer to avoid such rip offs? First, ignore the picture on the card or the “identity” of the card. A credit card is a tool, not a means of expression - would you use a hammer made out of balsa wood if it was emblazoned with Hello Kitty or the logo of your favorite NFL team? Next, don’t encourage your children to use credit cards when they’re young. Keep everything in tangible cash so that they really understand the concept of money. Credit cards add an abstraction layer that makes it hard for many adults, let alone children.

Tammy wrote in with the following story and question:

I recently got an offer in the mail from Sallie Mae, whom I currently have huge loans from, for a platinum plus credit card with worldpoints rewards. They are offering zero interest on balance transfers till october 2008 and cash back rewards and points (1:1) for what seems like everywhere i will use this card. What I am wondering is would it be a good idea to except this offer considering it is from salliemae. my thoughts on sallimae are a bit tainted and i feel like this is just another way for them to screw me over, although i’m not sure how.

I have alot of student loan debt and am living paycheck to paycheck with just barely being able to put something away. I figure I can use this credit card instead of my debit card so that I can gain the points but pay it off as soon as i use it to buy anything so then that way I’m not aquiring more debt but able to gain rewards.

Are credit cards with rewards a ploy or a great way to get something back? Does it matter that its being offered by Sallie Mae, does that discredit it in some way?

Rewards programs on credit cards are generally legitimate and work just as described. For every dollar you spend using the card, you receive some amount of benefit in the card’s rewards program, which you can convert to cash, gift certificates, or whatever the card provides. Thus, if you use the card and pay it off in its entirety every month, they actually are giving you free stuff to simply use the card to make purchases.

Why do they do this? It’s a simple fact that the average American has significant credit card debt, and anyone that has outstanding debt on their credit report is even more likely to have credit card debt. It’s when you don’t pay off the card in its entirety that they make money off of you.

Here’s an example. Let’s say Joe has a rewards credit card that gives him 1% cash back on all purchases - it also has an 18.9% APR after the end of the grace period. Each month, he puts $100 on the card and pays it off in its entirety. In December, Joe is tied down with Christmas expenses, so he buys $1,000 worth of Christmas presents and only makes the minimum payment, carrying forth $980 into February, where he pays the whole thing off.

Joe is way more diligent than the average American with his card, but here’s the interesting part. His entire year worth of credit card rewards adds up to $21. Those two months of leaving a $980 balance costs him $30.90 in interest. That’s a net gain by the credit card company of $9.90.

For credit card reward programs to pay off, one has to be very diligent and pay off the entire balance absolutely every month. If you fail to do that, it doesn’t take much at all for the benefit of the reward to disappear.

Rewards enticements are a very smart move - for the credit card company. Just as you received this offer and are considering it, millions of other people get similar offers and consider them, too. Some of them get the card. Almost all of them misuse the card and thus their reward program benefits are overshadowed by the credit card interest.

Another pointer: shop around for rewards programs. Most of the ones people get in the mail are pretty substandard - a good rewards program should be getting you at least a 2% return, if not better. My primary use card gets me well above 3% in the form of a rebate on my next car purchase - for every dollar I spend on the card, I get on average about $0.03 in an account that I can redeem when I buy a car. Here’s a guide to finding a rewards card that matches your personal habits.

If you think a rewards credit card is tempting, ask yourself honestly if you will be carrying a balance on it at any time. If the answer is yes, don’t get the card - you’ll lose money at the end of the deal. If the answer is no, shop carefully for a card that matches you. In either case, I probably wouldn’t ever get a credit card offer that was directly mailed to me without request - there’s always something better than that offer out there.

In response to my two recent posts on building credit (getting credit without a credit card and building up credit), Konstantin writes in and says:

I am following your blog daily and I found two conflicting ideas you suggest that I have a hard time reconciling them:

“Another tip is that by canceling credit cards, you’re actually hurting yourself in two ways. First, you’re reducing the total available revolving credit that you have without reducing the amount of current debt you have, thus raising your credit ratio. Second, by eliminating lines of credit, you’re shortening your credit history. Simply put, if you’ve already got a credit card and paid it off, don’t cancel it; put it away somewhere safe.”

VS.

“Keep the total amount of your credit cards’ available credit low”

So, if I cancel a card and/or if I have several cards - it’s bad BUT if I have several cards the combined credit limit reduces my debt ratio.

What’s the right way then?

These things are only in conflict if you carry a significant balance on your credit cards. Here’s what the game plan should be if you want to get your credit in good shape.

First, pay off all of your balances. Get those cards paid off, whatever it takes. Credit card debt is not healthy debt - the sooner you get rid of it, the better.

Once you’re on this level playing field, cancel some of your cards. I recommend keeping your oldest card and the one with the best bonus program and eliminating all of the rest, including the store-based cards. Why? A large total credit limit can be detrimental because it indicates to lenders that you have the potential to very quickly go deeply into credit card debt.

Once you’re there, use the bonus card, but try to keep the monthly balance under 20% of your total credit limit. For example, if the total limit on your remaining cards is $20,000, don’t carry more than $4,000 on the card if at all possible.

Doing this will keep the total amount of available credit low while not hurting you for eliminating lines of credit and altering your debt-to-credit ratio. The end result? A much better credit rating.