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.

Mark writes in and asks:

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.

Over the last few weeks, several people have written to me asking about the credit cards that I actually use. I use two of them, and here’s how I use them and why.

My primary card is the Citi Driver’s Edge Options Platinum Mastercard (here’s Citi’s page about the card). It gives me 6% cash back (for the first twelve months) on all supermarket, drugstore, and gas station purchases (it goes to 3% cash back after that), plus 1% back on everything else. On top of that, I earn $1 cash back for every 100 miles I drive, which I can prove with regular auto maintenance receipts - it basically winds up being $30 back every time I get an oil change, plus the 1% I save on that purchase. Over the first seven months of use, I’ve received back about 4.7% of what I’ve put onto the card.

My other card is the Chase Amazon Visa (here’s Chase’s page about the card). I use this one exclusively for Amazon purchases, which include a lot of my non-perishable goods and almost all of my entertainment expenses. I earn 3% of the purchase in store credit at Amazon, which has added up quite a bit in the last year ($125 in credit).

These two in tandem have earned about 4% in rebates since I began using them. Their rewards match my life very well (I commute and most of my card spending is at supermarkets, gas stations, and online) and thus I can really capitalize on them.

How do I keep them paid off? Each week, as part of my bill paying routine, I check the balance of both cards online and pay it off. This keeps me from ever seeing a dime in fees. This does mean, though, that I have to be very vigilant in not spending too much with the credit cards; I have to remember at all times that “future me” is going to have to pay this off, and “future me” is very, very real.

Aren’t credit cards in opposition to your “no debt” philosophy? My view is that a credit card in which you don’t carry a balance (effectively a charge card) is just a tool to make purchasing easier, and with the rebate options available, it’s a tool that actually pays you to use it. If I end up paying for this debt, it’s my own fault for not properly managing the cards. Credit cards are only dangerous if you start allowing yourself to regularly carry balances on them, and the greater the balance, the greater the danger.

I often get emails from readers asking me what the “best” credit card offer is. I write back and say there isn’t one, which I’m sure doesn’t win me any friends, but it’s the truth. There is no best credit card for everyone, but I’ll certainly say that the best offer for you probably wasn’t that Citibank offer you got in the mail last week.

Yet, time and time again, people sign up for whatever credit card happens to be most available to them, even though they’re often just handing wads of cash to the credit card company for the convenience. I think a credit card can be a valuable purchasing tool if used correctly and in a healthy fashion, but you’re simply losing out if you don’t select a good card for primary use.

So how do you find a good one? First of all, do a little self-evaluation…

Will you likely carry a balance on the card?
If you will be carrying a balance on the card regularly (in other words, you won’t be paying the full balance on the card each month), then the interest rate trumps every other factor about the card. Here’s what to look for in a credit card offer:

Introductory rate How much is the rate at first? Hopefully, this will be 0% or something very close to it. An introductory rate above 5% is not impressive.

Length of introductory rate How long does that rate last? The longer, the better.

Billing and grace period Two-cycle billing is bad; avoid it if you can. Also, the longer the grace period, the better.

Balance transfer rate and timeline Many cards give you the opportunity to transfer a high balance on another card to this card at that low introductory rate. However, read the fine print - the interest rate on the transfer may be different, as may the period, as compared to the introductory offer.

Long-term rate The long-term rate is less important than the introductory rates. Especially notice the adjusted rate if you’re late with a payment.

On many offers, the amount is based on the prime lending rate, which you can easily find by Googling for “prime rate” - as of this writing, the prime rate is 8.25%. So, if an offer mentions prime plus 12.99%, your real rate is actually 21.24% - ouch.

How will you use the card?
If you do pay your balance each month, then the bonus offers become much more relevant for you. Here’s some advice on how to find the perfect credit card offer in your situation.

Carefully evaluate your spending Look through all of your expenditures in the last three months or so, and group them not only by type but also by where you made the purchase. The largest groupings you have are the areas you should look for bonuses on. For example, my biggest expenditure over the last three months is our automobile - for gas, oil, and such things.

Check directly with major credit card companies Don’t Google for offers - almost any term combination you type in will result in a bunch of spam for substandard offers. Instead, go directly to the major banks that offer cards - Citibank, Chase, CapitalOne, and Bank of America, for starters - as well as directly to the major credit companies - American Express, Visa, MasterCard, and Discover - to find offers.

Focus on offers that match your spending Since you’re not going to carry a balance, your primary focus should be on cards that offer significant rewards. Look for ones that align well with your spending and also with your lifestyle. For example, I’m a heavy commuter and I put a lot of miles on my vehicle, as does my wife, so for us, the Citi Driver’s Edge Platinum Select is a very good choice. On the other hand, perhaps you are very very diverse in your purchases, so a direct cash back card like the Citi Dividend card might be appropriate.

The key is to look at a multitude of offers and really try to balance what they offer with what you actually spend, not with your perception of what you spend. If you do this - and keep the balance paid off - you’ll end up money ahead for having used the card.

Isn’t recommending a credit card bad advice?
Credit cards are only what you make out of them. If you make bad decisions, credit cards can certainly amplify the mistakes, but if you make good choices (like keeping the balance paid off), they can be incredibly useful tools that make your shopping much easier and can put money back in your pocket.

A reader recently sent in this question about her boyfriend’s credit, which seems to be on the cusp of being quite good.

My boyfriend was recently denied financing on a used upright piano because of poor credit. He actually has enough cash saved to buy it outright, but the fact that he couldn’t receive financing was a wake-up call.

Neither of us had checked our credit reports in about two years, so we both ran them through the government’s free program. His score is 611 and mine is 718. So, while I’m doing OK and already know what I need to do to get a higher score (namely just continue to pay down my credit card as quickly as possible), he’s in a trickier position. The key problem is that he’s never had a credit card and just doesn’t have much credit history; he was trying to be smart and not get caught up in credit card debt. He only has one late payment noted on his account and it’s from when he was 18 (he’s 26 now). I recommended that he open an account right away, use it to buy a few things every month, and then pay it off each month. He has a car payment and student loans which he pays on-time, but that’s about it.

Do you have any tips for improving his credit quickly? The two things he’s going to do now are: 1) Sign up for a credit card and pay it off each month; 2) Look into a couple things on the credit report that don’t seem quite right. I realize that it takes a while to build credit (I’ve had a credit card for 8 years, and it still says that one factor counting against me is a short credit history). It’s very likely that we’ll be getting married and looking to buy our own home in the next 5 years, and we want to do everything we can to set ourselves up for financial success.

First of all, his credit score is likely 611 mostly because of a lack of credit history. Most people begin to build their credit report - good or bad - during their late teens and early twenties largely with credit cards. Although he has some credit (the student loans and car payments), the lack of at least a small amount of revolving consumer debt (i.e., credit cards) has prevented him from having a higher score.

Now, about that late payment: if he made the error when he was 18 and he’s now 26, it should be very close to disappearing from his credit report, as late payments only stick around for seven years. If you pull out your full credit report (you did keep a copy, I hope), check and see when the exact date of the late payment ding was. When that’s more than seven years ago (right now, stuff in 2000 is starting to vanish from credit reports), it disappears from the credit report. If that’s truly the only negative mark on the report, his score should see some sort of bump after the late payment goes away.

So, what can he do to actively raise his score? The two suggestions you gave are both great ones (check out anything odd on his report and have him get his own credit card and use it regularly for small purchases). You didn’t really specify what the “odd” parts of the report are, but if you don’t know what something is on your credit report, you need to track it down and be sure. My wife and I went through this recently before we went in to get preapproved for our mortgage, and it was a good move.

About your credit score: Yours is 718. Keep doing what you’re doing now and you should be fine. Don’t cancel your oldest credit card, no matter what. If you keep the card paid faithfully and also don’t make other late payments on other bills, it’ll all work out just fine and your score will inch upward. Honestly, though, you don’t have much further to go before housing lenders will be 100% okay with your number.

Another thing that you both should do is really understand how your FICO score works and also know ten common mistakes to avoid when trying to raise your credit score. Both of those articles should offer some great additional advice to help you out. Good luck!

I often write these posts with CNBC on in the background for some noise (interestingly, I usually can’t see the television), and for what seems like the fifteenth time in the last hour, they’ve played a commercial for the Chase Freedom credit card. You’ve probably seen the commercial if you’ve had your television on at all in the last month … it features a single line from the old Rolling Stones’ song “I’m Free” over and over again. I’m free… to do what I want… any old time.

Apparently, the advertising scheme is working, because several people have written to me in the last week asking me about the offer: is it worthwhile? The short answer is that it’s not.

When I look at a credit card offer, I look at five crucial factors to judge whether or not it’s worthwhile.

Is it from a widely accepted credit card chain? I generally discard offers from Discover, and I almost always discard offers that aren’t from American Express, MasterCard, or Visa right off the bat because these cards simply aren’t widely accepted. If I can’t ubiquitously use the card, it becomes much less of a tool for my spending.

Does it have a grace period? I look for cards that have some sort of grace period on purchases before the interest rate kicks in. I’m very methodical and timely with my payments, so having a grace period usually means I pay no interest at all on virtually any of my purchases.

Is the interest rate low? Sometimes, I do wind up paying interest on a card, particularly when I’m on the road. When this happens, I want the interest rate to be nice and low.

Do I earn more than 1% cash back? The best cash back card offers award more than 1% cash back. If the card can’t even do that, then it’s out.

Do I earn more than 2 points on the average dollar, and can I actually use them for something I want? If I’m going to go for points, I better be earning a lot of points and it better be for things that I use. Since we do a lot of our bulk shopping on Amazon.com, for example, we really clean up on the bonus points with our Amazon card - we can effectively get 3% cash back on our bulk purchases.

So, if we take a look at the specifics of the credit card offer itself, we can quickly see how it does with this criteria.

It’s widely accepted; it’s a Visa. That’s a positive.

It has a 20 day grace period. That’s not particularly stellar; some cards have a longer period. But, still, better than no grace period.

The interest rate isn’t so good. The card has several “levels” of interest rates, but even the best one isn’t stellar - 14.24% variable is the best they can do, and that’s the best rate? 14.24% variable means that the interest rate can be adjusted upwards for a huge variety of reasons. I’m not comfortable with that kind of interest rate.

It earns only 1% cash back. That’s not good.

It earns less than 2% rewards points unless your spending is focused entirely on groceries, gas, and fast food. If you only use a card in those categories, you can possibly beat 2%, but for most people, the points won’t add up to 2%, so I don’t even care how good the stuff I can get with the points is.

Some people have wondered to me if the commercial is saying that you earn both cash and rewards points from the card. No, you don’t; you can choose which one you want to get, but you do not earn both at the same time.

In short, don’t go for the Chase Freedom card. If you want to read about a card that matches my criteria for a good card, check into the Citi Driver’s Edge Platinum Select card. If you commute to work, you can easily leverage this card to earn 3 to 4% cash back on all purchases overall, and it at least matches the Freedom card in the other categories.

Over and over and over again, readers ask me some variation on this question:

I have $1,000 in my hand. I am trying to decide if I’m better off paying off part of my credit card debt or investing it. What should I do?

The thing is, my answer is almost always the same, and I thought that because it’s asked so often by email, it might be worthwhile to spell it all out in detail here because if a lot of my readers are asking, it’s probably a question that many more have, and also so that when people write to ask in the future, I can send them to this post for an answer.

First of all, this is not a question about which option is the better investment. That’s not even a question. The average credit card debt runs about 16%. The average investment earns about 8%. Treating it as cash earns nothing. Thus, the three options are pretty well graduated: paying off the credit card will net you the most “return” on your money, simply because the negative growth (for you) of your credit card balance will far exceed the positive growth of most investments.

So why even look at this question in more detail at all? The problem is that most people look at investments based solely on the expected rate of return - and that’s a mistake. With these figures, there’s a major additional risk factor that hasn’t even been mentioned to this point, one that could potentially make the investment option seem better than the credit card payoff. What is it? The person in debt is the risk factor.

In the past, I discussed how human nature is a massive investment risk, and this is perhaps the most clear cut example of what I’m talking about. Our friend here has an outstanding credit card balance in the thousands. This means at some point in the recent past, our friend has spent significantly more money than he/she has available. This is an investment risk.

Let’s say you have two people, one of whom has no credit card balance and one of whom has a $5,000 credit card balance. You can give one of them a $100 bill, but you must give it to the one who will spend it more responsibly. Who would you give it to? To me, the answer is clear: the person with no credit card balance is much more likely to be a responsible spender.

So, let’s roll this back into the original question. There is a significant risk that if the person uses the money to pay down the card, he/she will charge the card up again. This basically makes the credit card payment no different than cash in hand - either way, the money is spent on material goods. Thus, putting the money into an investment that’s difficult to touch, like a Roth IRA, may be a better choice.

What’s the best solution? Cut up the credit card and delete the number from any online accounts, then use the cash to pay down the balance. You’re eliminating (or at least strongly reducing) the human risk from the best investment option available to you, and thus in the long run you’ll reap the rewards by having significantly lower interest payments.

This overall philosophy is true no matter what the debt, unless the debt is a very low interest one. If that is the case, the investment might be the best option of all no matter what.

We are at that very point in time when a 400-year-old age is dying and another is struggling to be born — a shifting of culture, science, society, and institutions enormously greater than the world has ever experienced. Ahead, the possibility of the regeneration of individuality, liberty, community, and ethics such as the world has never known, and a harmony with nature, with one another, and with the divine intelligence such as the world has never dreamed. - Dee Hock

Meet Dee Hock. You’ve probably never heard of the man unless you’re a business school graduate or in the banking industry, but his story is one of the most amazing things I’ve ever heard, tying together chaos theory, hidden organizations, and the reason why credit card companies get away with charging 18% or higher interest rates. Sound crazy? Look at the Visa logo on your credit card and ask yourself this question: how can I invest in Visa? What company is behind that logo? It’s a ubiquitous logo, but the organization behind it is a lot less clear to the casual observer.

Let’s rewind back to 1966 for a moment. The modern credit card was in its infancy, but the names Visa and MasterCard were still yet to be born. Instead, banks were restricted from having branches in other states, so individual, small, competing banks were issuing hundreds of different credit cards and hemhorraging money in the process, because businesses had little interest in accepting dozens of different credit cards. Bank of America of San Francisco came up with the innovation of franchising their card to other banks nationwide, so banks in many states were issuing a BankAmericard; however, these banks were still directly competing with each other from the ground up and many other credit cards were attempting to franchise.

Enter Dee Hock, a vice president at a bank in Seattle that was one of the franchisees of the BankAmericard. During a BankAmericard franchisee meeting in 1968, he stepped forward and said that this entire problem had a solution, one that would not only turn this whole mess around, but would make everyone involved a whole lot of money.

Dee Hock basically created the modern concept of how a credit card works. Instead of it working like the fast food industry, with a bunch of franchises all operating under the umbrella of one overall company (like McDonalds, for example), he founded BankAmericard as a separate company (and eventually renamed it Visa). It’s a privately held company that sells only one thing: cooperation. Anyone that wants to have that Visa logo on their own credit card, and thus be accepted wherever Visa is accepted, just has to follow a few basic guidelines put out by the company: that Visa logo has to appear on the lower right corner of the card, for example. This meant that any number of banks (or any business, for that matter) could make a Visa card, make up whatever rates and fees they wanted to, and have that card be used at any business that accepted Visa cards. Several banks signed up very quickly in the early 1970s and began to issue a lot of cards with the Visa logo on them.

Then, the company turned around and started going to every major retailer in the country, showing that they had a ton of people with these cards ready to spend money, and showed how easy it was, so that these business, for just a little fee per transaction, could offer the service of having a Visa card. Before you know it, almost every business in America suddenly had a Visa logo on their door.

Obviously, lots of consumers wanted the ease of use that came with a credit card, and since this ease was a brand new thing, a new set of rules could be laid down. It didn’t take long for the companies that sold the cards to quickly latch on to very high credit card rates - and because of the complete convenience of it, the consumer didn’t really care at all. The concept of the modern credit card was so brilliant that credit card sellers got away with charging incredible rates - and they still do.

So where did this idea come from? Basically, banks compete with various credit card rates, but also cooperate on the basic pieces of the credit card network: all transactions with a Visa card, regardless of who makes it, are basically identical in terms of the retailer. It’s a balance between the order of cooperation and the chaos of the competing credit card market, a concept which Dee Hock invented wholesale from his readings on philosophy and chaos theory.

What’s the moral of the story? Never stop learning about everything you can, because even ideas that seem completely unrelated can suddenly click together so easily that you can literally make trillions of dollars. No one drew a connection between bank lending, business organization, and chaos theory before this, but many banks now make billions off of this simple idea - and most Americans buy in because the end result (the credit card) is so elegant and effective.

Plus, now you have an interesting little anecdote to share with your friends.

The problem is never how to get new, innovative thoughts into your mind, but how to get old ones out. Every mind is a building filled with archaic furniture. Clean out a corner of your mind and creativity will instantly fill it. - Dee Hock