You Need at Least 2 Credit Cards
Credit Cards can be one of the trickiest areas of personal finance. As a financial planner, I actually spend way more of my time than I should have to walking my clients through how to make their personal credit work for them instead of against them. It isn't their fault, credit cards come with all kinds of nasty tricks and surprises, and they don't always work the way that you might think.
The media doesn't help by hyping up various fears about credit and credit cards. The truth is most people will never have any big problems, but they are sure to get dinging over and over again by the little things. For this reason, some of my clients go extreme in the opposite direction by trying to have no credit cards, or only one credit card. This sounds good in theory, but real life isn't theory. Here in the real world having no credit cards or even just one credit card is likely to hurt way more than it will help.
Assuming that you've decided to be responsible with your credit and that you've read the other articles here on Finance Gourmet so that you know about all the little tips, and ticks and inside secrets about credit cards, then you are going to need to have at least two credit cards.
Your credit score depends on a lot of factors. A lot of those factors are secret, but one of the big factors is the ratio of available credit to used credit. To put it another way, how much of your possible credit balances you've used up. So, if you have two credit cards, each with a $5,000 balance and you have $1,200 on one and $1,300 on the other, then you have used 50% of your total debt. The lower the number the better your score.
It Doesn't Matter That You Pay Off Your Cards Every Month
The very common misconception is that if you pay off your credit cards every month that the balances do not show up on your credit report and therefore, not in your credit score. WRONG! Every month your credit card company reports your balance to the credit reporting companies. So, if you have a great rewards card (you should) and you use it to buy everything (you should) then, you will have a balance. Yes, that balance is in the grace period, but it is still a balance. Let's say it is $2,400. The credit card company will report that you have a $2,400 balance. During the next month, you pay the full $2,400 so that you don't owe any interest (good job). However, during that month you'll buy more groceries and gas, and whatever, so at the end of that month you have a balance of $1,800 which gets reported.
So, unless you stop using your credit card for a whole month, you will have a balance each and every month and that balance will be calculated as part of your debt to available debt ratio.
If you have just one credit card, your credit score can fluctuate a lot based on nothing more than routine circumstances. If you have one credit card with a $10,000 limit and you normally buy $2,500 worth of stuff each month and pay off your balance every month you would think your credit score would constantly be fabulous. Keep in mind that even though you pay off your balance every month your ratio is still 25% because that $2,500 still counts.
But, if you buy Christmas presents in December your balance might be $5,000 which raises your ratio to 50%. Take a vacation in July and hotels, cars, and plane tickets add up to $8,000 you have a terrible 80% ratio.
Your Credit Score
I won't insult your intelligence by explaining to you why your credit score is so important. I will tell you that more goes into your credit score than just being good with your personal finances. You money and your spending habits are only part of the equation. A big factor is good reports from credit companies. The longer those reports are the more they count. Having three good reports is better than having one. So, if you have two credit card companies saying good things about you on your credit report, then your credit score will be higher than if there is just one. Also, keep in mind that how long those reports are open counts too. So, if you have just one card and it gets bought out by another company, or changes the terms, or you get terrible customer service one day and you cancel that card to get a new one, then your nice long positive report becomes a much lower scoring closed account report and your new credit card gives a short report. Your credit score just went down, and you didn't do anything wrong.
Fortunately, there is an easy fix. If you plan to use one good rewards card (you should), then get at least one other credit card that has the same or higher balance. The second card can be either another great rewards card, or one with a super low interest rate depending on how you plan to use it. If you don't use the second card, your ratio can never be higher than 50%!
So, now, when you take that vacation and your $8,000 balance is compared to $20,000 in limit instead of $10,000 then your ratio is a much better 40% instead of 80%. The same trick even helps on normal months by reducing that ratio to 12.5%. So, your credit score will always be a little bit better.
There is also the practical matter of being better able to deal with emergencies. Let's say that when you get back from that vacation you find out that the air conditioner has gone out. Sure, you are savvy in the ways of personal finance and you have an emergency fund for just this sort of thing, but now you can conveniently use your 2nd card to pay for the new installation and just pay it off next month at your leisure.
Use the articles here at Finance Gourmet to learn all the tips and tricks. Then use us to help you find good cards. Then, make sure you get at least two. (Frankly, I'd shoot for four or five, but that is another story)