Cut Up All Your Credit Cards?

Early in my college years, I was constantly warned about the evils of credit cards. Horror stories were told of people who got in over their heads and eventually went bankrupt because of their high accumulation of debt. If a person had a credit card, they’d always be tempted to spend more than they could afford and be enslaved by minimum payments and accumulating interest. The solution given to me and many others who did not already have established credit was to never apply for a credit card. The advice to everybody else who had cards was to cut them up and never use them again or at least for the foreseeable future.

This advice, while having the appearance of wisdom, is not actually wise for everybody. It’s only good advice for impulsive people who cannot manage their own spending, or who have not mastered the art of using credit cards to their own advantage. For everybody else, especially those who have never established their own credit, it’s incredibly bad advice.

Doing some side work now in the mortgage business has been quite enlightening regarding people’s view and use of credit. Usually what happens is a potential borrower contacts me about securing a loan for a home purchase or a refinance. After taking down some basic information I inform them that I have to pull their credit. Within moments I am able to see the potential borrower’s credit score from the three major credit bureaus (a word of advice: always check your credit report each year because it’s very common to find errors. Also, always get your credit scores. Free reports usually don’t include the score for free, but it’s worth the cost to know your score. And don’t just get the score from only one bureau, get it from all three. Lenders almost always use the middle score, and if you only pull one score, it may not be the one on which you’re actually judged) and also their credit usage history.

After pulling the reports I very often find that people have dug themselves into a hole with their credit cards: very high balances, late payments, etc. But I also find another interesting scenario: would-be borrowers who have no credit cards and show little if anything in their actual credit file. The problem with this is that to obtain favorable loans (or a loan at all), you have to have a proven record of responsible use of credit.

So here’s the problem: No or bad credit history = no or low credit score = no loan ineligibility or sky-high interest rates.

At least the guy with the diminished credit can still maybe be approved for a subprime loan. But the young guy with no credit file and little if any money for a downpayment, will not get a loan at all. Not only that, but when he finally wakes up and realizes that it’s very hard to be economically successful with no credit history, he finds that it’s incredibly hard to establish credit. When the bank or whoever finally approves the consumer for a card it usually has a very low credit limit and very high interest rate. That’s OK, there’s still hope. Just keep reading.

When I talk to people who have the thin or nonexistent credit files, I ask them if they’ve considered taking out a credit card or department store card. Their response is like mine used to be: “Well, I always thought credit cards were a bad thing so I just avoid them.” Some remark, “I have a debit card, does that count”? (The answer is no for credit building purposes).

The hysteria against credit cards is an overreaction to the larger cultural problem of debt irresponsibility. You can have a credit card, including those really high-interest ones, and be completely responsible and never even pay a dime of interest as long as you have it. The solution is very simple: pay your balance in full each month. Forget the “minimum payment.” The minimum payment is designed to keep you enslaved to debt and make the lenders more money. Instead, you can make more off them in terms of convenience, building your credit file, and earning gimmicky “rewards” from the issuers, just for using your card responsibly. As long as you don’t spend more than you can completely pay off each month, you’re fine, and you’re not sinning or being wasteful by using a credit card in the process.

Let’s say you’re a grown adult who has never taken out any revolving credit in your lifetime (or maybe no credit period) and you’ve struggled to finally get approved for a card. They wind up giving you a card with a low credit limit of $500 and a 22% interest rate. Here’s what you do: just put some gas and food on the card each month and pay it all off every month, ignoring the “minimum payment.” Don’t ever be late. Do that for six months and you’ll be on the map with a credit score.

Give it another six months or so and apply for another card advertising great rates and rewards. After a year of responsible, timely credit usage, you’ll easily get approved, have a much higher credit limit, and a much better interest rate. But you won’t need to worry about the interest rate anyway since you’re going to pay it all off on time anyway. If you do leave a balance on occasion (as some credit building strategists advice), keep it small. Another thing lenders look at is what your available credit limit is in proportion to the amount of credit still available. The more credit available, the more responsible borrower you appear to be and the higher your credit score. Also, don’t close out that old card. Keep it as an active trade line by charging a small purchase or two a month each and then pay it all off.

On a whole, credit cards can be very convenient. But don’t look at them as a tool to “buy” something today and pay it off next year. Your purchase will wind up costing you much more than the original price after interest piles on. Think of it as buying something today and paying for it in a couple weeks. Instead of carrying around large sums of cash, you can instead pay with your card, and then in a couple weeks pay off your card online with convenient online banking (Who still sends checks these days? If it’s you, get with the times!). And in the process your credit score grows and your purchasing power increases. Make your credit a tool for your own success instead of an instrument of irresponsible spending and piling debt.

Bankers have a name for people who use credit responsibly and as a tool for their own success: they call them “deadbeats.” That’s because when you use credit to your own benefit, you are enriching yourself, and not the banks.

Anti-debt hysteriacs are leading too many young adults astray with their fear mongering of credit cards. They have “thrown the baby out with the bathwater” to use an odd expression. They assume that everybody who uses credit cards is on the path towards bankruptcy, just as many teetotalers assume that every person who enjoys an occasional glass of wine with dinner is on the fast track to becoming an alcoholic.

They even go so far as to say that taking out a home loan is sinful or economically unwise in every circumstance. So unless you have 100K upfront to fork over for a small and modest house, you should rent your entire life rather than buying a home in your price range with payments you can realistically afford. Nevermind that some of these “debt-free” enthusiasts are multimillionaires. Their books sales and radio shows enable them to put all the money down for their homes and follow their own advice. Most likely, you don’t have that luxury. Nor will you ever have much purchasing power if you avoid credit completely.

So, cut up all your cards? Only if you’re impulsive and have no self-control. If that’s you, then yeah, you need to go cold-turkey and get the temptation out of your path. But for everybody else, you’re much better off to use debt and credit to your advantage. If you haven’t established any credit yet, now is the time to get started. And one of those little cards might just be the trick.