It may seem funny since my blog is all about saving money and being a cheapskate, but I am encouraging everyone to never close a credit card because it will COST YOU MONEY.
Used correctly credit cards can be a great way to save (and even make) money. This is counter to what many Debt Elimination programs preach. Indeed Ramsey says “There is NO positive side to credit card use. ” I like both Dave and John’s programs and follow much of their advice, but on this point I strongly disagree, credit cards just need to be used responsibly.
I will break down 3 main reasons not to cancel your credit card.
1 – It will hurt your credit rating.
2 – Its an interest free loan.
3 – Rewards.
1 – A large component of your credit rating is credit utilization. That is the percentage of credit you are actually using. If you call and have a credit card canceled you are reducing your amount of available credit so you utilization will go up and your credit rating will go down.
For example, lets say you had two credit cards with a $5000 credit limit and they were both maxed out, this would but your credit utilization at 100% and would greatly reduce your credit rating. Now lets say through saving and scrimping you were able to get one of them paid off. Great your credit utilization has gone down to 50% this will be a nice boost to your credit rating. But you decide to follow the advice of the Dave Ramseys of the world and cancel the paid off card, what happens? Your credit utilization goes back to 100% and your credit rating drops back down.
Another component of your credit rating is the length of time you have had credit. If that credit card you just canceled was a very old line of credit you could be in for a double whammy hit on your credit rating.
2 – Where else can you get a short term loan for no interest than a credit card? Just make sure you pay off the full balance of your credit card every month on the due date and its a free loan. I do put everything I can on my credit card. If I am going to buy $30 in groceries today, by putting it on my Discover Card® , I wont actually have to pay for 1 – 2 months (depending on my billing cycle). That is $30 I can have in my Bank of Internet Checking Account earning interest. Obviously keeping $30 for an extra month or two will not make you rich, but if you do this with all your spending all the time, it will add up.
If you want to take it to the extreme, have plenty of time on your hands and are very disciplined you can take it to the next level but taking advantage of all of those 0% or low % initial balance transfer offers that credit card companies use to get people to sign up. Over at the fatwallet finance forum there is a group of people that participate in what they call Application-O-Rama’s (AORs) where they get as many 0% credit as they can max out the balance transfers and put the money in interest bearing accounts. Even if this is done correctly it will at least temporarily hurt your credit rating and if not done correctly could devastate your credit rating and end up costing you a lot of money. For that reason I don’t recommend anyone does this unless you take the time to fully understand it.
3 – Rewards!!!! Everyone likes free stuff. Everyone should be getting some kind of rewards with their credit card. Personally I like cash. Paying your regular bills with a credit card is a great way to get free money. You are going to have to pay your cable bill every month anyway, by paying it on your credit card, not only are getting a month of two interest free loan on that money, you can get a 1-3% discount on your bill, why would you want to turn that down. Currently I am using my Discover Card® to make all my gas purchases, they have a 3 month promotion where I am getting 5% cash back. With current gas prices that means I am saving over 15 cents a gallon!! Shop around for the best rewards programs for you, some have certain categories that they will give better rewards for.
Dave Ramsey’s reasoning for saying credit cards have no positive side is that people will spend more if they use credit cards. For me that’s hogwash, and I think most people can be disciplined enough to use credit cards responsibly. If you know yourself and know you can never be disciplined though, then by all means cut up your credit card. Or use John Cummuta’s recommendation and put your credit card in a tin can of water and put it in the freezer, that will keep you from making impulse buys. But whatever you do DON’T CLOSE your credit card, even if you don’t get the advantages of reasons 2 and 3, at least keep the line of credit open for your credit rating.
If you do have dormant credit cards make sure you keep track of them!