What You Need To Know About Opening (And Closing) A Credit Card
Don’t lie — when you hear the words “credit card,” you probably cringe and think about a big dark spiral down into the pits of debt hell. But Ariel Anderson Fortunato, a certified financial planner at Society of Grownups, told Swirled that when used correctly, credit cards can be amazing financial tools even though they get a bad rep.
“You can reap financial rewards and track and categorize your spending,” she said. “They even have better fraud protection from most debit cards.”
Ultimately, you need to know what happens when you actually open one (and when you close one).
Fortunato said that the first step to understanding credit cards is to understand your credit. There are three major components to credit: percentage of online payments, length of credit history and credit utilization ratio, which is how much of your available credit you’ve used up. For example, if you have a credit card with a $10,000 limit and you use $3,000 each month, your credit utilization ratio is 30 percent.
Your use of a credit card greatly affects these three credit components. Fortunato said that there are pros and cons to opening a card as well as closing a card. Here’s the good and bad of each.
Opening A Card
Pro: You have more available credit, and when a credit card is used wisely, it can help boost your credit score.
Con: Your length of credit history is shortened. Credit history is an extremely important detail that banks look over before deciding whether to give you a loan you’re requesting. Your credit history length is an average of all the forms of credit you have, so opening a new line cuts the history short.
Pro: You’ve just added a line of credit to your overall mix. Credit diversity, meaning that you are using multiple types of credit like using cards or retail cards and paying off loans, is important when building up your score and financial reputation to lenders.
Con: You’re making a hard inquiry on your credit report. “It’s a small hit [to your credit score], but the inquiry stays on your report for two years. If you’re opening a bunch of cards at once, it could make you look desperate to lenders,” said Fortunato.
Pro: You may have access to new rewards or perks. For example, a travel-specific credit card could hook you up with free flights or stays in hotels.
Con: Opening a new card may entice you to overspend, especially if overspending is already a problem for you. “If you’re prone to carrying a balance on your credit card, opening a new one will maybe encourage the bad behavior,” said Fortunato.
Closing A Card
Pro: You can eliminate any potential annual fee for a card you’re not using.
Con: Your credit history will also be shortened when you close a card. “Sometimes keeping a card open is easier, especially if it’s an old line of credit,” said Fortunato.
Pro: Having fewer cards simplifies your financial circumstances.
Con: Because closing a card reduces your line of credit, it also reduces your overall available credit, which could affect your utilization credit.
Fortunato also recommends following some of the following best practices when using a credit card:
- Always know what your credit score is and know how to check it and really stay on top of it. Fortunato recommends using free websites like CreditKarma, which allows you to check your current score at any time.
- Make sure you’re paying off your balance every month. If that’s not realistic for you right now, pay the minimum at the very least and on time.
- Look out for hidden fees! For example, you may sign up for a store credit card with 0 percent interest and not realize that the 0 percent interest only lasted six months. After those six months, maybe that card has a ridiculous interest rate that you’ll be slogging through if you’re unable to pay the balance each month.
- If you have cards you don’t use regularly, still check the monthly statements just to make sure nothing funky is going on, like fraudulent activity. “It shouldn’t be out of sight, out of mind,” Fortunato said. “Your inactive cards also might be canceled by your institution if you never use them, so make sure they stay active.”
- Cutting up a card doesn’t cancel it… period.
Ultimately, credit cards don’t have to be these daunting money suckers. “It’s really all how you use it,” said Fortunato. “If you can maximize points and get free rewards, sometimes you have a real financial reward that impacts your circumstance.” It is possible to have a positive relationship with your credit card. You just have to be educated on how to achieve it.