Sasha writes in with a typical question:

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.

When I was near my financial low point, I was literally paying hundreds a month in finance charges on my credit cards. That money was an enormous burden at the time, since I didn’t have any savings built up and I was also dealing with the “startup” expenses of having a new baby in the home.

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!

This week, The Simple Dollar is taking a deeper look at five common personal finance debates.

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.

Jon writes in:

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!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The “Facts”?

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

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

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

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

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

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

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

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

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

What Does This All Mean?

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

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

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

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

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

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

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

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

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

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

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

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