Close cards the smart way

Dear Liz: My wife and I have opened about 20 credit cards, including retail cards, over the past 12 years or so. We have no balances on any of these accounts. We recently bought a home and don’t plan to apply for any new loans in the near future. Should we close all these accounts and take the potential credit hit now, in order to have a much cleaner credit sheet after a few years?

Answer: One of the many persistent myths about credit is that having too many cards is bad for your credit scores. In reality, the leading credit scoring formula, the FICO, doesn’t punish you for having “too much” available credit. You can, however, hurt your credit scores by closing accounts.

If you’re not going to be in the market for a new loan any time soon, you can certainly close a few retail cards if you no longer use them and don’t want the hassle of keeping track of those accounts. But you’ll probably want to keep open your major credit card accounts (Visa, MasterCard, Discover, American Express) unless there’s a compelling reason to close them, such as an annual fee you don’t want to pay.

The hazards of asking for a lower rate

Dear Liz: I would like to get my interest rate reduced on a couple of my credit cards. I’ve never been late on a payment and have decent credit scores. But the last time I called to ask for a reduction, the credit card company raised my rate and lowered my limit. I’m hesitant to call and try again. Any suggestions?

Answer: Unless your credit scores are excellent (typically FICO credit scores of 740 or above), these days you probably shouldn’t waste your time trying to negotiate a lower rate with your current issuers.

People with great credit have some leverage, because they can easily transfer their balances to competitors offering low rates. People with only “decent” credit usually can’t qualify for those offers.

You may be able to get a better deal by transferring your balance to a three-year, fixed-rate personal loan. Check with your local credit union first, as these member-owned organizations often have better rates and terms.

How to use credit cards to improve your scores

Dear Liz: I’m working off credit card debt. I have two cards down to a zero balance. Which will improve my FICO credit scores the most: leaving the cards open but not using them or using them minimally and paying the bills off in full each month?

Answer: Congratulations on your progress paying off your debt. Erasing your debt on those two cards is doubtless already helping your scores. You can continue to improve your numbers by using the cards lightly but regularly, paying the balances in full each month.

Credit scoring formulas want to see you actively, and responsibly, using credit. Shutting the cards in a drawer won’t demonstrate that you can do that. You’re also running the risk that a card issuer will shut down your account because of inactivity.

If you discover you can’t use the cards responsibly, however, then locking them in that drawer (or freezing them in ice) is better than running up credit card debt again.

Why you should have more than one credit card

Dear Liz: I recently applied to refinance my mortgage. The lender sent me a copy of my credit reports and scores. My FICO scores from all three credit reporting agencies were OK, just a little under 800, but under the heading “Key Factors affecting credit score” was the following statement: “Proportion of balance to credit limits too high on revolving accounts.” I have only one credit card, which I’ve had more than 20 years. (Several department store credit cards were closed, with no balance, many years ago.) I never exceed 10% of my limit, and on the date the report was issued, my balance was 7%. You frequently advise borrowers to limit credit card charges to a small fraction of their limit to help their score. How can 7% be considered too high? Is it possible there is an error somewhere and I should investigate?

Answer: If your FICO scores are close to 800, they’re more than OK — they’re excellent. And once scores are that high, the reasons the credit bureaus give you for why they’re not higher are pretty much irrelevant. Even if you could fix the purported problem, it probably wouldn’t affect your numbers that much.

But you should consider adding another credit card once your refinance closes. A second card could serve as a backup if your primary card ever gets temporarily shut because of fraud. A second card also gives you somewhere to go if your issuer raises your rate, cuts your credit limit or starts imposing unreasonable fees. It’s not smart in today’s financial environment to be beholden to a single credit card issuer.

Skimping on credit card payments can damage scores for years

Dear Liz: I am expecting a settlement from an accident at work that will allow me to pay off my credit card debt completely, but in the meantime I am having a difficult time financially. If I were to pay less than the minimum amount required on my two credit cards, I assume that my credit score would take a drastic hit. How long would these negative marks remain on my credit history and affect my score? Would this prevent me from getting financing on a new house if I have since paid off all creditors?

Answer: If you have good credit scores now, it could take up to three years to restore them after you’ve failed to pay a bill. The negative marks themselves will remain on your credit reports for seven years, but their effect on your scores diminishes over time if you make no other credit mistakes.

Clearly, the best solution is to pay at least the minimums on your cards until your windfall comes through and you can pay off the debt entirely. Going forward, you should avoid carrying credit card debt. The only smart way to use plastic is as a convenience, not as a way to live beyond your means.

If you’re not able to pay the minimums, you can talk to your issuers to see if they have a temporary hardship plan that will allow you to reduce the amount you pay. Ask about the hardship plans’ effect on your credit, though, since these arrangements also may hurt your scores, depending on how they’re reported to credit bureaus.