Yesterday, I received a notice from [my credit card company] that my credit limit had been lowered from $10,000 to $4,000 on my primary credit card. I was immediately worried that my credit had been damaged by identity theft, so I checked it on annualcreditreport.com and there was nothing there at all. I’ve always paid all of my bills on time and my life has been pretty much normal and unchanged for a long time. Why would they make this change? I’m not concerned about reaching my credit limit, but that reduction in my limit does alter my debt-to-credit ratio, which could negatively impact my credit rating.

Jennifer describes a pretty typical scenario today. A credit card company sends a letter out of nowhere, for no obvious reason, announcing a significant drop in one’s credit limit.

One big effect that such a drop has is that it alters your debt-to-credit ratio, as Jennifer mentions. Simply put, your debt-to-credit ratio tells what percentage of your credit limit across all of your credit cards you’re actually using. So, let’s say Jennifer had a $3,000 balance on her $10,000 card – that’s a 30% debt-to-credit ratio. When the company drops her credit limit, she then had a $3,000 balance on a $4,000 card – that’s a 75% debt-to-credit ratio. The higher your debt-to-credit ratio, the more negative impact it has on your credit score.

This type of behavior seems alien, particularly after a decade where credit card issuers would commonly raise credit limits without you even asking. What gives?

The reality of the credit card industry has changed. For one, the econmic downturn has seen a large spike in the number of people who have simply defaulted on their credit card bills, not bothering to pay them. For another, the Credit Cardholders’ Bill of Right Act recently became the law of the land, restricting some of the business practices of the credit card companies.

Credit limits are not a right. Another issue is that many people, particularly after the last decade of rampant growth in credit limits, view their limits as something of a right and when credit card companies reduce those limits, their rights are somehow being infringed. In truth, that’s not the case at all – your cardholder agreement makes it very clear that your credit limit and your interest rate can be changed at any time.

So how do they decide when to lower your limit?

They watch what you buy via data mining. Every time you make a credit card purchase, the credit card issuer’s computers store a record of that purchase (you’ll see such information on your bill). Obviously, this is a wealth of information, one that they can use to figure out all sorts of things, such as where you live (so that if you suddenly make a rash of purchases elsewhere, they can throw a block on the card).

They draw conclusions based on what you buy. Another thing that they do is watch what you buy. They look at the places you normally shop and draw conclusions based on that.

Let’s say Jennifer normally shops for clothing at, say, Banana Republic (I don’t know this, I’m just creating a hypothetical example). Based on this, the credit card company would conclude that she fits the profile of an average Banana Republic customer, meaning she has a fair amount of discretionary income.

Now, let’s say Jennifer is suddenly a bit worried about the economy. She and her husband decide to curb their spending and she starts doing things like buying soap at the dollar store with her credit card.

When the credit card company analyzes the data, looking for spending changes that might affect credit limits, they’ll observe from their data that Jennifer is spending a lot less at the Banana Republic and a lot more at the dollar store. That means she’s got a different spending profile – one that signifies the potential for financial trouble.

They act in accordance to those conclusions. Given their recent problems with people defaulting on credit card debt, they take pre-emptive action and reduce her credit limit.

To Jennifer, this seems sudden and unfair – and for good reason. She’s likely not in any true financial trouble at all and is simply choosing to be a bit thrifty in these uncertain times.

What can you do to protect yourself? The truth is that Jennifer should avoid being in any kind of position where such a credit limit change has any impact at all on her. In other words, don’t be reliant on that piece of plastic. Use it as a tool instead of as something you need to have.

One big way to do that is to never carry a balance on your card. If a bill comes at the end of the month, pay it off. If you’re thinking of making a purchase where you wouldn’t be able to do that, you can’t afford that purchase. Wait a few months and save up the cash.

This not only keeps your debt-to-credit ratio pretty low, but it also leaves you out of any sort of “danger” from the credit card company adjusting your limits or your interest rates. More importantly, though, it prevents you from building up a significant amount of debt on the card, which can be very, very difficult to pay off.

Use your credit cards wisely and changes like what happened to Jennifer will have little or no impact on your life.

To put it simply, the raising of credit card rates shouldn’t matter to a person who has control over their financial life. If you don’t carry a balance on your credit card for longer than the grace period, it doesn’t matter what the interest rate is.

Based on the comments I read there, a lot of people do the same exact thing I do. I use credit cards for their convenience and the rewards they provide. I pay off the balance in full each month (I pay all such bills on the 1st and 15th of each month, actually, to keep it simple).

There’s one big problem with this plan, some will point out. It puts you at risk. What happens if you can’t pay the balance at the end of the month?

For starters, I never, ever carry a balance that’s more than what I have in cash in my emergency fund. I never even come remotely close. In fact, I never come remotely close to carrying a balance that’s more than what’s in my checking account. If I’m turning to my emergency fund, it’s a genuine emergency, not just a great sale at the store.

Which brings me to the second point – effective credit card use requires a lot of self-control. I am speaking from experience here – I learned the hard way about what damage a credit card can do if you don’t have self-control. It took a mountain of debt and a point that was perilously close to personal bankruptcy (while having a baby at home, no less) to force me to wake up to the truth – that a credit card without self-control is like a chainsaw in the hands of a toddler.

If you aren’t spending less than you earn month in and month out, you should go cash only, because cash provides the hard limits that are needed when you don’t have your spending under control. Credit cards are only beneficial to people who spend less than they earn every month, like clockwork. If you can’t or aren’t doing that, the drawbacks far outweigh the benefits for credit card use.

When the credit card companies raise interest rates, it’s not the financially stable people who are punished – they are often barely aware of rate changes because they’re unaffected by the changes. Instead, it’s the people who don’t have self-control – the people who carry a balance – who are punished by the changes.

Yet again, it’s a fantastic argument for living frugally, responsibly, and below your means – if you do so, the games companies play with credit card rates don’t affect you.

If you’re carrying a balance right now and your credit card company has just adujsted your rates, I have a simple plan for you: cut up your credit card. It’s doing you much more harm than good right now. Then, focus intensely on paying off the debt. Absorb as many frugality ideas as you can and try them in your own life. Knock down your life’s routines and build new ones – your old routines are the ones that brought you to this point. Seek out friends who don’t find their self-worth in the things they have. Seek out activities that don’t drain your wallet.

And gradually, you’ll find that credit cards don’t have to be dangerous – they can merely be useful tools – and that you don’t have to worry about rate changes.

Good luck.

But should you close it? This is an interesting debate that often comes up in personal finance circles. I think there are benefits and drawbacks no matter which you choose and the “best” answer isn’t absolute in all cases.

So let’s dig in.

If you keep the card…
If you decide to keep the card, there are a few things you should think about.

First, simply having the card is a small identity theft risk. If you’re no longer actively using the card, the risk is pretty small, and you can make the risk even smaller by taking action.

Second, not closing the card opens the door to spending temptation. Obviously, if you have the strength of character to pay off all of that debt, you’re able to keep the temptation in check.

There are two big steps you can take to reduce the two risks above even more, chopping them down to an incredibly tiny sliver.

For one, destroy the physical card. Cut it up so that there’s no risk of losing it or having it stolen. I tend to actually melt used credit cards over an open fire (seriously – I’ll toss them into campfires).

For another, remove your credit card information from any online retailers that may still have it. Check your Amazon account or any other retailers you might use and make sure your zero balance card isn’t listed there. Just get the information completely out of the system.

If you cancel the card…
Let’s say you decide to cancel the card. What are the drawbacks of canceling it?

The big one is that canceling a card results in a negative bump on your credit score. This negative bump goes away after roughly a year, but during that year, your lower credit score can have some short-term negative implications. It can cause your insurance rates to go up. It can reduce your chances for getting work.

The big one, though, is that it can also hurt you if you’re attempting to get a mortgage. A lower credit rating right at the time when you’re attempting to secure a home mortgage is not a good choice.

So what should I do?
From my perspective, the answer is simple. Before you do anything, ask yourself if you’re going to be changing jobs or getting a mortgage or a car loan in the next year.

If you’re looking forward to a major move like this in the short term, don’t cancel the card. The risk of the short term drop in your credit rating is higher than the risk of just cutting up the card and forgetting about it.

Instead, cut up the card, but hold onto the account until you’re past that hump that you’re facing in the short term. When you’ve made it, then make the call and cancel that credit card.

On the other hand, if you don’t see a major move in your future, cancel that card. Doing so eliminates the temptation and eliminates the (small) chance of identity theft.

I don’t understand why I need credit at all. Credit just gets you into debt and you wind up paying interest to other companies. What’s the point of throwing my money away like that?

Samantha asks a really good question here – and in some respects, she’s spot on. Poor use of credit is a big net loss for people. Because of the interest payments, you lose far more than you gain.

However, there are a lot of upsides to healthy use of credit.

First, a good credit rating helps your insurance rates. Insurance companies use your credit rating as a factor in determining what sort of rate to offer you on homeowners insurance, auto insurance, and life insurance. The higher your credit rating – meaning the more reliable you are at obtaining credit, then paying the bills faithfully – the better you seem as a risk, because people with high credit are statistically more likely to be safe drivers, safe homeowners, and likely to live longer.

Second, a good credit rating helps you with employment options. Similarly, many employers run credit checks on potential employees and, again, are much more likely to hire people with strong credit because it’s a clear indication that they’re reliable.

Third, credit often offers great buyer protection. If you use credit to make a purchase – particularly credit cards – the cards offer a lot of protection against fraud, identity theft, and other serious problems. If you pay cash, you miss out on those protections.

Fourth, a good credit rating helps you with renting. Even if you’ve made the decision to entirely avoid credit and rent until you can write a check for a home, your credit still affects your housing because many landlords – particularly those in charge of higher-end housing – will check the credit ratings of potential renters and will reject (or charge a much higher deposit) people who have no credit or poor credit.

In the end, it pays to have a strong positive credit rating. This does not imply, however, that it’s good to be in debt. You can have a great credit rating without digging yourself into debt. Here’s how.

First, get a credit card. If you have no credit history, you can usually get one with a low credit limit pretty easily. Look for one that has some sort of bonus connected to a retailer you use. If you shop at Target, get the Target Visa. If you shop at Amazon, get the Amazon Visa. If you get all your gas at BP, get the BP card.

Second, use the credit card for routine purchases. If you stop for gas, use your card and pay at the pump. If you’re at the store buying some items you need and would buy normally, use your card for that routine purchase. Other than these events, forget about the card entirely.

Then pay off your bill in full each month. If you stick to just using the card for routine purchases, you should have no problem whatsoever paying off your entire bill each month. Thus, you never incur debt that generates interest.

Instead, you get all the benefits of a positive credit rating – lower interest rates, better job application success, buyer protection on some purchases, and better housing opportunities – plus the benefits of the rewards of a good credit card – discounts at the retailers you already use. Together, these add up to a net positive, and if you’re disciplined enough to keep yourself from using the credit card for purchases you would not make without it, it’s nothing but a positive.

Here’s another way to think about it. Your credit rating is simply the method many businesses use to figure out if you’re reliable or trustworthy. If you are, they see you as having more value – you’re likely to be a better employee, you’re less likely to have insurance claims, and you’re more likely to pay your rent. By avoiding credit, you’re sending no signal at all to them – and thus they’re unable to decide if you’re reliable or not and thus won’t offer you the best rates.

Positive credit helps you in many ways and saves you money consistently. Don’t avoid all credit because of a fear of debt – responsible people can enjoy all the benefits of good credit without the drawbacks of bad debt.

Good luck.

Washington Wire summarizes the bill very succinctly:

Existing balances: Issuers cannot retroactively change the rate on an existing balance unless the account is 60 days delinquent.
Payments: A consumer payment above the minimum applies first to the balance with the highest rate.
Teaser rates: Issuers cannot raise rates for the first year after an account opened. Promotional rates must last at least six months.
Bills: Issuers must send a bill 21 days before the due date.
Over limit: Issuers cannot charge over-limit fees on credit cards unless the consumer has signed up to allow such transactions.
Minors: For consumers under 21 years old, a company must get the signature of a parent or another to take responsibility for the debt, or it must obtain proof that the under-21 consumer can repay credit.
Disclosure: Cardholders must get 45 days notice of change in terms.
Fees: Issuers cannot charge fees to pay by mail, phone, and electronic transfer or online, except for expedited service.
Gift cards: All gift cards must have at least a five-year life.

Meanwhile, The Wallet offers a few predictions for what this means:

“We’re in uncharted territory here,” says Curtis Arnold, head of CardRatings.com, a credit-card comparison site. Mr. Arnold says consumers can expect issuers to work overtime to lure high-end, high-volume clientele while adding fees and rate hikes for customers with less-than-stellar credit profiles.

The rationale is that credit-card issuers make money off interchange fees (fees merchants pay to card issuers). So customers who charge everything and pay off their balances are seen as less risky and still profitable by card issuers.

The future of rewards programs is also up in the air. Mr. Arnold advises cashing in reward and airline mile points, as their purchasing power has been on the decline in the last year or so. However, he points to new cards from brokerages like Charles Schwab and Fidelity, which offer higher cash-back rewards that lure customers to their brokerage products.

Mr. Arnold also advises those customers with existing balances to pay them off as soon as possible and consider transferring them to smaller banks and credit unions, which may be able to offer more generous rates and repayment terms. He, and others in the industry, expect interest rates on existing balances to keep climbing before the proposed legislation kicks in. (An optimistic guess would be that card issuers would have to comply nine months or a year from now.)

Something else to keep an eye on: Annual fees. The era of reward cards, or even non-reward cards, with no annual fees may be at an end. Stay tuned to notices from your card issuers and the changing fine print of your statement

So what does this mean for you?

First of all, these rules do help people avoid getting into trouble with credit cards. I applaud the change that requires minors to get parental approval or to prove they have the ability to repay before getting a card. I also like that all extra payments always go to the portion of the balance with the highest interest rate – no more shenanigans with companies applying overpayments to 0% balance transfers. Eliminating fees for different types of payment is also a plus.

But what else will change? It’s important to remember that the full ramifications of this bill won’t be seen immediately. Obviously, the credit card companies will try to keep their level of profits the same, which means that, inevitably, they’ll have to change their business in some ways. However, as Arnold noted above, they don’t want to kill the golden goose – the interchange fees that they rake in as a result of wide credit card use.

So, beyond the immediate impact for credit card users noted above, I’m going to make a few predictions about how this bill will affect things over the long term.

Interest rates will keep climbing. The days of easy low-interest credit are ending. That means the role of the credit card will begin to change as smart consumers begin to use credit cards more like charge cards – they pay off the balance in full at the end of each month.

What this might mean for you: Paying down your credit card balances as soon as possible is more important than ever! If you’re carrying a credit card balance, now is the time to start buckling down and wiping out that debt. If you aren’t carrying a debt on your cards, don’t start one – stick to spending less than you earn and keep using the credit card as an intelligent tool.

The credit card syndicates (Visa, Mastercard, etc.) will seek to raise interchange fees as a first line of attack. Credit cards work most effectively when lots of consumers have them and then expect this service from merchants. Think about it from Target’s perspective, for example – if half of their customers use credit cards to pay, they’re somewhat tied to offering that service to customers. Thus, I predict credit card companies will use that to their advantage and raise interchange fees, particularly on large retailers.

What this might mean for you: Many merchants will attempt to recoup this increase in interchange fees by passing the cost along to the consumer, so I would expect a slight bump in prices – 1% or so, spread out over many purchases and items. For most people, this will largely go unnoticed and will be seen as normal inflation.

Credit card issuers will get clever with fees, but annual fees won’t return. Most consumers have come to expect that their credit card will have no annual fees, so I don’t believe these will return in wide use. Instead, the companies will see other avenues for fees – cards that require a minimum number of uses per month, cards that have fees to enroll in particular rewards programs, and so on.

What this might mean for you: You’ll have to be more careful with credit card offers in the future. Also, when there are updates to your terms, you’ll need to read them carefully. Again, if you keep your balance paid, your credit will be good, so you can walk away from any cards that try to slip sneaky fees in on you.

I don’t believe rewards programs will go away. I would expect, though, that rewards programs will become more tied to specific “partner” retailers, like Target and Amazon, and away from more general programs like Drivers’ Edge. Why? Merchant-specific cards encourage loyalty to those merchants, and that has quite a bit of value to the merchants – those aren’t programs they will want to see go away.

What this might mean for you: Don’t be surprised if you find some of your rewards programs changing, particularly when your current card expires. For now, though, stick with what works for you.

Any thoughts or predictions on this new world of credit card rules?

The Credit Card Accountability, Responsibility, and Disclosure Act of 2009 would forbid card issuers from opening accounts for people under 21 unless one of these criteria is met:
+ A parent, guardian or other responsible individual agrees to co-sign for the debt.
+ The applicant provides proof he or she can independently repay the debt.
+ Proof is provided that the applicant has completed a certified financial literacy course.

I understand where this bill is coming from and I agree with it in large part, but I would be opposed to it overall. Let’s look at both sides of the coin.

What I Like About the Bill
When I was a new college freshman, I signed up for a credit card in exchange for a t-shirt, then I began to use it for all kinds of stuff – video games and so on. In short, I acted like a fool with that credit card – a card I would have never had if this act had been in place.

A bill like this would unquestionably have kept me from getting into this early credit card debt. My parents would not have signed off on such a card and thus I would have been forced to learn how to manage the money from my part-time job more carefully, teaching me some valuable budgeting lessons.

I also strongly agree with the idea of basic financial literacy being a requirement for credit card use, though I’m not convinced at all that this is the way to do it.

What I Don’t Like About the Bill
What I don’t like about the bill is that it takes away personal responsibility in two different ways.

On one side of the coin is the fact that many people under the age of 21 are fully independent and have their head on their shoulders. One individual I know had a very successful business he was running himself at age nineteen. I know several others who have been through trade school and are embarking on plumbing and electrical careers at that age. Why should these independent and self-motivated individuals be required to find someone to co-sign with them for a credit card?

On the other side of the coin is the lessons learned from credit card ownership, which might actually be easier before age twenty one for many. I didn’t figure out how to use credit cards sensibly until age twenty seven, but I’ll be the first to admit that I didn’t receive a great education on how to use them and what their role should be in your life. If I had, I might have been able to make sense of my earliest credit card troubles (when I was in college) when the amount of debt wasn’t that much at all. For many people, college is a time to learn and make mistakes and grow – this bill just offers more hand-holding.

For me, the negatives of this bill outweigh the positives.

Is There A Better Solution?
The solution needed here is pretty simple – there is a desperate need for better consumer education. Consumer education should be a part of the school system from the earliest stages. Reading, writing, and arithmetic are fundamental, but so is managing your money – not knowing how to do that in the modern world can derail your life.

Instead of sponsoring bills that restrict the freedoms of adults, why not invest a bit more in education and a bit less in other areas?

What do you think? Is the Credit CARD Act of 2009 a good thing or a bad thing on the whole?

Along those same lines, Tim writes in recently:

Am I better off using a charge card or a credit card for buying stuff?

At first, I just assumed that Tim had replaced “credit card” with “charge card” in his vocabulary and I began to answer that question, but then I realized that it’s worthwhile to distinguish between all three types of cards and their advantages and disadvantages. So let’s go through them one by one.

Credit Cards
A credit card is borrowed money. When a company issues you a credit card, you’re given a specific credit limit – the maximum amount you can borrow from the company. Each time you use the card, you borrow some amount from that company, and each month, you’re required to pay back a portion of that amount to the company. Mastercard, Visa, and Discover are the major types of credit cards.

Advantages The biggest advantage of a credit card is the flexibility. You can make purchases without actually having the cash on hand at the moment. You also have an indefinite amount of time to pay back that money, though you do have to make a minimum payment each month on what you owe. Many credit cards also have rewards programs, which return to you 2-3% of your purchase price in some form or another – often in the form of gift certificates or rewards programs. Also, good credit card use helps you to build a good credit report, which can save you money on insurance and help you with loans. Consumer protection with credit cards is usually pretty strong, too – they’ll often help you deal with fraudulent purchases and don’t leave you out to dry if you lose the card.

Disadvantages The big disadvantage is that all the flexibility is a double-edged sword. The ease of use of credit cards and the lack of pressure to pay off what you owe makes it very easy to make poor purchasing decisions. Then, when you can’t pay off the card, you usually pay a hefty amount of interest on that unpaid amount – and over a long period, that interest can be incredibly costly.

Debit Cards
A debit card, on the other hand, is linked to your checking or savings account. Each time you use the card, money is automatically taken from your checking or savings account to cover the purchase. Many debit cards have the same purchasing flexibility as credit cards, as many are accepted where Visa and Mastercard are.

Advantages You can’t get into debt trouble with a debit card. It does not allow you to buy things that you don’t have the money for. For people struggling with debt, this is a huge advantage because it keeps you out of trouble. Plus, they’re flexible and convenient for day-to-day purchases. You also don’t have to have good credit to get a debit card – you often get one with your checking account.

Disadvantages The biggest disadvantage is that you have to keep a very close eye on your account balances, because you can overdraft your account if you’re not careful. Another disadvantage is that very few debit cards have rewards programs of any kind. Debit cards often don’t have the same consumer protections that credit cards and charge cards have – if your card is stolen, your protection against unauthorized purchases can be weak.

Charge Cards
Charge cards are often confused with credit cards, but they actually function in a fairly different fashion. Like credit cards, charge cards extend credit to you from the issuer, but you’re required to pay the full balance at the end of the month. Some charge cards also have an annual membership fee. Charge cards are typically associated with American Express; many store chains often issue their own charge cards as well which can only be used at that store.

Advantages You don’t have to have the money on hand for a purchase with a charge card, nor do you run the risk of carrying a balance that will charge you interest. Many charge cards have tremendous bonus programs that go from things like 5% cash back to free companion flights on airlines – their bonus programs are typically better than bonus programs for credit cards. Charge cards often come with additional services and benefits, like free roadside assistance, free food at airports, and free hotel room upgrades. They also help your credit much as a credit card does. Most charge cards offer strong consumer protection as well, similar to that of credit cards.

Disadvantages Some charge cards have an annual fee which eats away at the benefits from using it. Also, since you are operating on credit, there is some risk that you might build up a large balance on the card that will be difficult to pay off. Many charge cards are usually pretty strict in terms of who they’re issued to – you need to have good credit before even getting one.

Which One Is Right For Me?
Many people wish to avoid credit at all costs because of the risk of debt – in that case, a debit card is obviously the right choice. If you’re seeing a great debit card (preferably one that has some semblance of a rewards program), you should investigate all of the checking options available at your local bank and also perhaps do some shopping for a new bank, particularly if you’re unhappy with your current bank for some reason.

I tend to believe that it’s worthwhile for everyone to apply for at least a single credit card and use it irregularly. It provides a very easy way to build a positive credit report and gives you some flexibility in purchasing. If you have a good rewards card (for example, I use my Citi Driver’s Edge card for all gas purchases), you can also earn multiple percentage points back in rewards.

If you have excellent credit, have a strong policy of paying your balances back in full each month on your credit card, and travel a bit, it’s worth examining some of the charge card offers available to you, particularly if you’re running a small business. Typically, one can get a big net benefit from a good charge card, but you have to be aware of the benefits alloted to you by that card. Plus, you can’t get into revolving debt trouble with a charge card since you have to pay the balance in full each month. I know at least one small business owner who makes a killing with his charge card, getting tons of free flights, free airport foods, discounts on rental cars, roadside assistance, free hotel rooms, business advice, and so on, but those are rewards that others may have difficulty maximizing.

My suggestion, if you’ve never owned a card, is to get a good checking account (I use ING’s Electric Orange as my primary checking and I’m happy with them) and use their debit card for most purchases. At the same time, get a credit card, use it for only a few purchases, and leave the card at home so you’re not tempted to use it. This allows you to start building healthy credit without the debt risks of a credit card.

Please, readers, fill in additional details you see as important – many more people than just Tim will find use with this information.

A lot of different personal finance bloggers have different ways that they use credit cards. Some of them don’t use them at all. Others seem to use them a lot. Where do you stand and why?

I started off answering this question for the reader mailbag, but then I realized the answer was going to be rather long and involved so I spun it off into its own post.

So, let’s break this down bit by bit.

How do you use credit cards? To put it simply, we use rewards cards for routine purchases in our life and pay off the full balance at the end of the month. If we can’t afford the purchase or haven’t budgeted for it, the credit card is not a crutch to help us purchase it.

What do you do in emergencies without the card as a crutch? We have a large emergency fund in place to deal with true emergencies – a car breaking down, a hot water heater failing, and so on. We’re able to have this emergency fund because we consistently spend far less than we earn.

Why not just use a debit card? Two reasons. First, a debit card doesn’t improve your credit score. A healthy credit score not only helps you out with things like car loans, it also reduces your insurance rates. Second, a debit card typically doesn’t provide you with any rewards for using it. Similarly, using a debit card means the money is directly pulled from your checking account, and since my wife and I have an interest checking account, we prefer to keep the cash in there so that it can earn interest before we pay the credit card bill at the end of each month.

What cards do you use? My wife and I, between us, have three active credit cards – a Citi Driver’s Edge Mastercard, an Amazon.com Visa, and a Target Visa. We use the Driver’s Edge card for gas and automotive purchases, the Amazon card for purchases on amazon.com, and the Target card for purchases from Target. This allows us to get roughly 3% back on all of our purchases on cards. These three cards take care of the vast majority of our purchasing on cards.

Don’t reward cards encourage you to spend more? No. These cards are tools, not excuses to spend more. They simply make the purchasing process more convenient (it’s easier to run a card than it is to fill out a check at the checkout) and occasionally earn us a nice reward – a 10% off card for Target, a $25 reward certificate for Amazon, or, occasionally, a check from Citi.

What’s the disadvantage of doing things this way? First of all, you have to be disciplined. If you’re tempted to buy unnecessary things simply because you have the credit to do it, this strategy won’t work. You also need to have the routine of paying your credit card bills down cold – even one late payment can wipe out the benefits of doing things this way.

To put it simply, I do not believe credit is inherently bad as some people do. I believe the big risk associated with this strategy is personal – it’s up to your organization skills and personal willpower to make it a success. I’ll be the first to admit that there was a time when I didn’t have either of those attributes – and it resulted in $17,000 in credit card debt. I had to learn how to use a card.

If you have those attributes, using a reward credit card for your routine purchases provides nothing but benefits – better credit rating, rewards, and convenience at the purchase site. For us, these benefits have been a great help over the past few years.

I didn’t know at the time that it’s actually not too hard to get your interest rates reduced on your credit cards, particularly if you’re in a situation like I was in. All you have to do is get your information together, call the credit card company, and be willing to play a little hardball on the phone, and you’ll often get a nice reduction in your interest rate. That will directly help your bottom line.

In fact, if I had been able to get a reduction in all of my credit cards when I was in real trouble, I would have easily saved $100 a month. That money, if used properly at the start of a financial turnaround, can make all the difference in the world. It can be the foundation of an emergency fund, light a fire under a debt repayment plan, repay a family member for a debt, and countless other little things that can make all the difference when you’re trying to turn your finances around.

Is This For You?
This tactic works best if you have a substantial amount of debt sitting on credit cards and have largely been able to make your payments up to this point. A few late payments are quite all right, but if you’re being chased by collection agencies, negotiating with the credit card companies won’t really help.

If you’re not carrying a balance on your card or don’t carry a balance regularly, the credit card company is not going to be particularly interested in helping you out because as a customer, you’re not putting much money into their coffers. Simply put, this tactic works best if you have some leverage – you’re currently paying finance charges on your card and you’re threatening to move it to another account.

Another important factor is your current interest rate. If your rate is already around 7.99% or so, there’s not much the credit card company can do to lower the rate. This tactic works best if you have a rate above 13% or so.

Remember, though, any interest rate reduction will help if you’re carrying a balance. A 1% reduction on a card where you’re carrying a $1,000 balance will save you $10 a year. If your balance is higher, you save more. If your interest rate reduction is higher, you save more. For example, if you have a $5,000 balance and get a 5% rate reduction, you’re saving $250 a year from a single phone call – well worth your while.

Preparing for the Call
While you might be tempted to just flip over your credit card and call the card issuer’s number on the back, you’ll have a much greater chance at success if you prepare just a bit in advance.

First, have a copy of your most recent statement with you. Make sure you know what your current interest rate is and also have your account number handy and easy to read. The statement should also provide you with the phone number you need to call.

Next, collect any other offers you might have available to you. See if you have any zero interest or low interest balance transfer offers available to you – in other words, check your recent “junk mail” and/or log on to your online access for your credit card and see what’s available. Get a quote on a personal loan from your local credit union’s website. These will be used as leverage to get your rate reduced.

You should also figure out a target rate to shoot for on the phone. I recommend shooting for 9.9%, but you’ll likely not get a rate that low.

Finally, get in the right mindset. Drink a glass of water. Get yourself calm (because getting worked up on the phone won’t help you), yet motivated to make this work. Then pick up the phone and dial.

Making the Call
The first thing you need to do is get someone on the phone that actually has the authority to change your interest rate. Likely, the first customer service representative that you speak to won’t be able to do that.

So, start off by navigating through their menu until you can speak to a representative. As soon as you can, ask the big question: “Do you have the authority to change my interest rate?” If the answer is no, simply ask, “May I speak to someone who can? Your supervisor, perhaps? Thank you!”

Once you’ve got a person on the phone who has the authority to change your rates, make your case as clearly and succinctly as possible. Here’s a potential script:

“Hello. Lately, I’ve been really having to stretch my finances to make the monthly payments on this credit card, and I need to reduce the interest rate somehow. It would be convenient to keep the balance on this card, but I have some other options that could really save me some money – a zero interest balance transfer offer is sitting right here, for one. Could you reduce the interest rate on my account to, say, 9.9%?”

This puts the ball firmly in their court – and at that point, it’s largely out of your hands. The typical response is a reduction in rate, but not a reduction all the way down to the rate you requested.

Regardless of what you get out of the call, be polite. Say “thank you” for any rate reduction and don’t get enraged if you don’t immediately get a big reduction.

Other Options
Sometimes, you’ll get a rate reduction that makes you happy. At other times, you may not get much of a rate reduction at all – and in that case, you’ll want to do something else. Here are some options.

Seek out balance transfer offers. Moving your balance to another card can help get the finance charge monkey off your back – a useful short term solution.

Seek out another type of debt. Investigate getting a personal loan at your local credit union. A home equity loan is a possibility, but it’s generally a poor idea to change unsecured debt (like your credit card) to secured debt (like a home equity loan).

Lower the offending debt rapidly. Focus all your energies on getting rid of that high interest debt as fast as you can. You might want to work a second job, sell some stuff, or start a side business to generate extra money – and learning how to live cheaper is always a big plus.

For most people with credit card debt, the possibility of success (and the savings that go along with it) with attempting to get your rate reduced is worth the effort involved in picking up the phone and doing it. Good luck!

Several people I know have made the active choice in their life to completely avoid the use of credit cards.

In the modern era, this seems like an almost shocking choice. Credit cards seem like the foundation of basic money management. We use our plastic everywhere as a matter of course, a fundamental part of how we do things like buy groceries and household goods and make other purchases.

Yet it’s a lifestyle choice that many make, and it’s actually not as difficult as it sounds. Over at No Credit Needed, there’s a great explanation of how one guy gets by using just cash and his debit card, no credit at all.

Is this a reasonable lifestyle choice, or is it just foolishness? Let’s take a look.

What Are The Options?
Credit card users are in the clear majority here. NewsHour reports that in 2001, 76% of Americans had at least one credit card to their name, and that number has certainly increased since then. Many credit card owners use their cards responsibly but frequently, taking advantage of the buyer protections offered by credit cards and the convenience of using them to facilitate day to day purchases. I know I’m certainly in that camp.

So what do the rest do? No Credit Needed explains things very clearly: a mix of electronic transfers, debit card usage, checks, and cash use. Coupled with a clear budget, this enables people following this kind of system to never “accidentally” slip into credit card debt – it provides a nice barrier of protection.

What Are The Big Differences?
The biggest difference between the two perspectives rests in the functional differences between a debit card and a credit card. A credit card tends to offer significant buyer protections and allows you to make any purchases you like up to your credit limit, but that’s a double-edged sword – you have a bill to pay, after all. A debit card may or may not offer buyer protections (you’ll have to talk to your bank to find out) and your limit is effectively the balance of your checking account, since any purchases on a debit card are directly pulled from there. There’s no bills at the end of the month, though, and the only danger is overdrafting.

So What Should I Do?
First of all, regardless on your feelings on the use of credit for regular purchases, it’s worthwhile to get a credit card. Establishing a positive credit history can only help you in life – it helps with insurance rates, the interest rates you might get on car loans and mortgages, and so on. If you object to using credit, just get the card, register it, put it back in the envelope, put it in a safe place, and forget about it.

Now, what about the use of credit cards in day to day purchases? I think it really comes down to psychology – do credit cards create a psychological temptation to spend more than you should or perhaps create a feeling of unease and a lack of trust in your own spending habits? If credit cards trigger either of these responses from you, then you’re likely better off not using one, because the concept of using a credit card is inherently altering your spending. Again, No Credit Needed explains it rather well – his debt was out of control and it was clear to him that access to such easy credit was a big part of the problem.

I think a period of “credit abstinence” is actually useful for many people, as it provides an opportunity to re-evaluate your priorities without an increase in your debt load. However, the convenience, buyer protections, and rewards of credit card use make it a valuable tool if you use it wisely – don’t carry forward balances, avoid “accidentally” being late, and so on.

I have a bunch of credit card debt spread across several different cards and I’m having a hard time getting started paying them off. You’ve offered a lot of little solutions for debt removal, but I need a plan I can execute to deal with these credit cards. How can I get rid of these debts?

I receive questions like Jon’s almost every week, usually involving a person who has realized that their credit card debt is completely out of control. They want to know what they can do to get out of the situation.

The most important thing to realize is that the best solution to credit card debt is a long-term one, not a “quick fix.” You’re going to need to make some alterations to your spending, because if you’re racking up that much credit card debt, you’re spending beyond your means.

Here’s a ten step plan for getting rampant credit card debt under control.

1. Hide Your Credit Cards
The first step is to hide your credit cards in a place where you could access them in an absolute emergency, but that they’d be very difficult to find. Put them in a little box way in the back up in the attic. Freeze them in a big chunk of ice. Hide them in the back of the cupboard at your mother’s house. Make sure it’s somewhere where you can’t easily access them.

Then, go to every online account where you use a credit card regularly and delete your credit card numbers there. Amazon. PayPal. World of Warcraft. All of them. Make sure that you’re not forgetting anything. If you absolutely must retain a service, use a debit card number instead of a credit card number.

Why do this? Your credit card balances need to go down, not up, and the biggest step in doing that is to break yourself of the habit of using them without a connection to the real money you’re spending. That means going back to using cash, checks, and debit cards – if you don’t actually have the money, you’re not spending it.

2. Figure Out What You Owe – And What The Interest Rates Are
The next step is to dig out the most recent statements for all of your credit card bills and determine exactly how much you owe and what the interest rates on each of the bills is. This information should be easily found on your most recent statement, but if you’re having difficulty finding the information, call up your credit card provider (the number on the back of the card) and get that information.

You should be making a list of all of these: credit card name/type, current balance, and interest rate. This way, later on, when you develop a plan, you can use this master list to figure out which credit card to pay first.

3. Request That The Companies Lower Your Rates
Now that you have all of your information at hand, go through them and try to get some of your rates reduced. For each card, call the phone number on the back and directly ask for a rate reduction. If you get a response that doesn’t give you what you want, ask to speak to a supervisor.

Some tactics:
+ Be polite, even if you don’t get what you want. Yelling won’t solve anything at all here and will likely reduce your chances of getting what you want.
+ State that you’re looking at transferring that balance elsewhere. This gives you at least some degree of leverage in the conversation.
+ Be realistic in your expectations. A 3% reduction IS a great success. If you have a $5,000 balance, 3% is a savings of $150 a year.

4. Look For Zero Percent Balance Transfer Offers
Once you’ve squeezed down the interest rates on your cards, see if there are any balance transfer offers available to you, either on your current cards or possibly on a new one (zero percent transfers are the best, but long-term ones that are lower than what you’re currently paying are solid, too).

The first place to look is with your current cards. Identify any balance transfer offers available with these (read the statements carefully) and note the interest rates and the term (the longer the term, the better, as after that term, you’ll start paying more interest).

Then, start transferring! Transfer your highest remaining card balances first and keep moving down the list until your interest rates are as low as possible. By this point, your master list has probably gone through lots of chicken scratches and revisions, so it might be worthwhile to just rewrite the whole thing with your current balance levels.

You should note that quite often doing balance transfers will result in a card having some of the balance at a certain percentage and the rest at another percentage. Since you often can’t control which portion of the debt you’re paying, I usually recommend figuring out the average interest rate for that card. So, let’s say you have $10,000 total on that card, with $7,000 at 3.9% and $3,000 at 18.9%. Just take $7,000 times 3.9 and add it to $3,000 times 18.9 to give you 84,000, then divide that by the overall bill total, $10,000, to give you 8.4%. This is the interest rate you should consider that card to have – it’s not perfect, but it’s a good thumbnail sketch. Recalculate it on occasion when you get a fresh new bill, as it will likely slightly adjust over time.

5. Look For Personal Loans
Your list of credit card debts should be looking a lot better, but let’s see if we can improve it even more by getting a personal loan. Stop by your local credit union, show them your credit card debt list, tell them your story, and ask if they have any options for consolidating these debts further. If your credit is still strong, you may be eligible for a personal loan; if not, you may still be able to get a solid loan anyway with some form of collateral (a home or something else of value).

Again, only accept such a loan if you’ve got a credit card debt with a higher interest rate still outstanding. If you can’t get a personal loan that beats any of your remaining credit card debts, don’t get one.

6. Liquidate
The next step is to liquidate some of your unnecessary possessions and use the proceeds to pay off the highest interest debts remaining. We all have stuff laying around that we don’t really need. When I went through my debt crisis, I liquidated a great deal of stuff – DVDs, video games, CDs, baseball cards, books, Magic: the Gathering cards, and some sports equipment went out the door in short order. Why? I wasn’t really using them and I knew that I could get some significant cash for all of that stuff.

Take a frank look at all of your possessions and ask yourself honestly which ones you actually are using regularly and which ones are gathering dust in the recesses of your shelves or the back of your closet. Then dig out those items and get some value for them. My recommendations:

+ Sell items that have significant individual value online, such as CD or DVD box sets, high-value individual trading cards, and so on. Those items will recover the value of the time you put into selling them online – most ordinary items won’t.
+ Take the rest of your unwanted items and attempt to sell them through appropriate dealers. Look to used media shops and collectibles dealers for places to unload the remainder of your items. If you’re trying to sell clothes, go to a consignment shop.
+ If there’s anything left, make a detailed list of it, take it to Goodwill, and get a receipt. This will help with taxes next year and you can use that tax rebate to help with your debt situation.

7. Develop a Debt Repayment Plan
Hopefully, your interest rate reduction efforts and your big sell-off have made your credit card situation a lot less scary. Now it’s time to develop a debt repayment plan. There are two big options.

The Dave Ramsey “Debt Snowball” plan means that you make a minimum payment on each debt, then make a large extra payment each month to the debt with the lowest balance. This will allow you to feel the success of eliminating a debt the fastest.

The fastest plan means that you make a minimum payment on each debt, then make an extra payment each month on whichever debt has the highest outstanding interest rate. This is the fastest route overall, but it doesn’t have that sense of success as quickly as Ramsey’s plan has.

Ramsey’s plan is easier to follow through on. The fastest plan will get you to debt freedom slightly faster. Both work. It’s up to you.

8. Practice Frugality and Snowflake
If you want to keep this train of positive progress going, the key is to learn how to be frugal in your day to day life. Look for ways to cut out unnecessary spending everywhere you look.

The best place to start is to evaluate your daily routine. Could you be using energy more efficiently? Is there anywhere you stop every day (or almost every day) to spend money? That’s likely a great thing to cut out of your routine.

How can this help? I like the technique known as snowflaking. Each time you make a choice that saves you money, immediately go home and take that much out of your checking account and put it into your savings. At the end of the month, sweep that total out and send it in as an extra debt payment. That way, you can directly see your frugal actions transformed into debt reduction.

9. Stick To That Plan With The Help Of Automated Payments
One way to ensure that you stick to the plan is to set up automatic payments through your credit card company and your bank.

Here’s one clever tactic. Set things up so that the credit card companies execute minimum payments automatically from your checking account. Then, set up with your bank a large extra payment each month to the credit card that you’re focusing on paying off. This way, you know your minimum payments are always correctly covered, plus you’re making a significant extra payment each month on one of your cards, too.

With everything being automatic, you don’t have to worry about anything other than making sure there’s plenty in your account to cover the transfers, and you can do that by learning how to be frugal with your spending. This plan also ensures no late fees or other unnecessary extra charges that you might accrue.

10. Don’t Stop
It might be tempting to stop this plan and go back to your old ways once the credit cards are under control.

Don’t. Reverting to your old habits will just cause this nightmare scenario to come back.

Instead, once your cards are paid off, start saving that money for your bigger dreams. Set up an automatic transfer with your bank into a savings account or an investing account each week so that you’re automatically saving. Eventually, that money can be used to buy a car or help you cover the down payment for a house – a much better outcome than a continuing spiral of credit card debt!

Good luck!

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.

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.

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.

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 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.

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.

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.

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.

I’m 18, and recently applied for a credit card at Citibank. They rejected me on the basis that I have no credit history. I’ve had a savings account at a local bank for nearly my whole life with all of my money in it, and I’ve started budgeting my money for when I go to college in September. So I know how to handle money, and I know all about interest rates and avoiding debt (partly thanks to your blog). Citibank has some of the best credit card deals I could find. But how am I supposed to build credit if I can’t get a credit card in the first place?

Mark actually has several options for building positive credit without his own unsecured credit card. Here are some ways that Mark can build credit in this situation.

Have his parents add his name to their card. They don’t even have to give him a card, just add his identity as an authorized user on their own card. This will make their card account appear on his credit report and thus he’ll get the benefit of their good management of their card.

Get a secured credit card. A secured credit card is one where you’ve already paid a certain amount before you get it – say, $250 or $500. Then, each time you use the card, it’s immediately paid out of that money and then you are billed for that amount to replenish the balance. This builds credit, and when you cancel the card, you get the money back.

Make a moderate purchase on a store payment plan. For example, you could purchase a piece of furniture at a furniture store or an electronic item at an electronics store. Sign up for their payment plan; it’s basically a form of credit. If you have a purchase you’re planning in the near future and already have the cash to pay for it, this is a route worth considering.

Get your student loans. If you’re 18 and planning on going to college, student loans are likely in your future. Your parents may have to cosign on them, but they’ll be in your name and be a very good source of credit.

All of these options will put you in good shape for the future. One tip: when you start to build credit, you will be inundated with all kinds of offers. Forget them and shred them. If someone sends you an offer in the mail, there’s likely a better one out there that isn’t wasting marketing money on direct mail campaigns.