There may come a time when you have no need to keep your credit score as high as possible. Perhaps you have no need for debt now and in the future. It’s not common, but there are a few methods of arriving at that point.

• You’ve fashioned a life for yourself off the grid. You are completely self-sufficient.
• You’ve been able to save enough wealth that any need you could possibly have can be covered with cash.
• You have no concern about any missed investment opportunities.
• The idea of using other people’s money as leverage bears to concern for you.
• You may be winding down your life, with no pressing medical issues and with the comfort of knowing your financial needs are winding down.
• You live in a community where credit isn’t a way of life. but if that’s the case, this article wouldn’t be of interest to you, anyway.

I applaud people living in modern society in economically developed nations who have shunned the use of credit despite its prevalence. To save money for everything before making a purchase is an admirable goal.

Credit will touch most people’s lives at some point, if not through the use of borrowing money with credit cards through a mortgage for buying a house. I frequently hear from people who have sworn to live a debt-free life, or are celebrating because they’ve paid off all their outstanding debt, but when asked, they add a caveat: “Oh, I’m not counting my mortgage.”

Don’t get me wrong — I’m always happy to hear when someone has completely paid off their credit card debt and their loans outside of their mortgages, but the missing piece represents the need for most people to maintain a strong credit history and high credit score.

If you’ll need to borrow money in the future, refinance a mortgage, apply for some jobs, or seek out an apartment or a house to rent, you’ll need to stay on the credit grid — in the system, so to speak — to ensure you’re not denied credit and to qualify for the best interest rates.

An interest rate that’s one percentage point lower than your neighbor’s rate can save you $50,000 over the course of a $250,000 30-year mortgage. And you could do a lot with that $50,000, and invested over time, that $50,000 could become a significantly higher nest egg.

Credit cards affect your credit score.

Two significant factors in determining your FICO credit score are the length of your credit history and your debt-to-credit ratio. Because these two factors are so important in determining your credit score, and therefore your qualification for the best interest rates in the future, there are some guidelines to follow to help you take advantage of your existing credit.

The most important guideline is simply to keep your old credit cards open, even if you don’t use them anymore.

I know there’s not many things more satisfying than paying off a credit card, shredding the plastic card, and calling the issuer to cancel the card. I’ve experienced that satisfaction first-hand.

This could have been a big mistake.

When I was working for a non-profit over a decade ago, I needed to earn some extra money, but I was starting from nothing. Actually, I was starting from less than nothing, several thousand dollars in debt due to student loans, an expensive commute, and my need to buy just the essentials for my life on credit. I wanted to build websites as a side business, and I was quite skilled at this at a time when web design and programming was a nascent industry. Unfortunately, I had no tools. I had a desktop computer that I moved from one living situation to another that was several generations beyond usefulness, and was beyond its capacity of functioning as hardware.

So I did what I could to jump-start the business. I used a retailer’s twelve-month introductory 0% APR special on their store-branded credit card to finance a purchase of a new notebook computer.

This was thirteen years ago, and I wrote on my personal blog at that time:

How can I afford it you ask? How could I not afford it? [...] Happiness costs about $1500. (Thank you Mr. Best Buy Financing Guy.)

That Best Buy credit card, issued by a company called Household Retail Bank, or HRS USA, became a thorn in my side. Like other customers experienced, after a few months, the issuer stopped sending credit card statements. As I was not particularly organized, I neglected to pay the bills every month from that point on. Had I received the statements, I would have paid — if I had the cash, anyway.

When I did receive a bill, several months later, I noticed HRS USA had charged me penalty interest back to the date of the purchase. I called and complained about the lack of statements, had them remove the penalty, and paid off the balance on the card.

And then I closed the account.

In the end, it’s a good thing I closed this particular credit card. The credit limit was low, $500 if I remember correctly, and it was my newest card. Those are the two things most important to check before considering closing a card. It did feel good to eliminate my interactions with that business, and it turned me away from Best Buy almost as much as their high prices.

Your credit cards contribute to your total available credit.

I don’t plan on closing any of my current credit cards, even though some are inactive. According to my Equifax credit report, which I checked today for free by using AnnualCreditReport.com, I have two open credit cards with a limit of $500, both American Express cards, two cards with very high limits, several with limits between $1,000 and $10,000, and one card — a Bank of America card — that does not report a limit.

According to the same report, my debt-to-credit ratio (or credit utilization ratio) — how much of the available credit I owe on a monthly basis — is 3 percent. Since I pay my credit card in full every month, that number won’t be consistent, it’s based on a snapshot of my credit at any particular time.

If I were to close my card with the highest limit, my debt-to-credit ratio would almost double, and that could negatively affect my credit score.

Your credit cards contribute to the age of your credit history.

According to my credit report, the average age of my credit lines is just over seven years. That’s not that long for someone who is thirty-seven years old, such as myself, and it’s only this long because it’s greatly assisted by my student loan account with the U.S. Department of Education, though now closed, originated in September 1995, my second year of college.

If I had a credit card at that time, the account been closed over seven years, not only no longer helping to increase the average age of my credit history, but not even listed as a closed account on my Equifax report. I have noticed that credit cards closed over seven years ago still appear as closed on the TransUnion credit report, so each bureau may handle this differently.

Like the Best Buy card opened in late 2001 and closed in early 2002, Equifax no longer keeps a record of the card’s existence. And therefore, they also no longer have a record of my missed and late payments.

I’ve had most of my active credit cards for less than my average credit history of seven years, so I wouldn’t close them now. There’s a good chance that closing one or more of those accounts will reduce the credit history as calculated by the credit bureaus, and that could reduce my credit score.

Sometimes, the choice to close a credit card isn’t yours.

I’ve had two credit cards closed by the issuer due to inactivity. Only some issuers will close a cardholder’s credit line if unused. Try to avoid this; since reading terms and conditions documents can prove to be a frustrating endeavor, call the issuers for any cards you don’t use that you’ve had longer than your average credit history. Ask the customer representative whether the card will be closed due to inactivity.

If so, keep the card active by using it for an automated expense each month, followed by an automated payment. That will keep the card active, and the automation will help you stay organized.

If you have two cards from the same issuer and want to close one, call first.

Suppose you find yourself with two Chase Visa cards, one a Chase Sapphire Preferred you opened one a year ago. The other is a standard Chase Visa card you didn’t realize you had until you reviewed your credit report and saw it listed as an active account from ten years ago. Call the customer service number and ask them to do the following:

• Assuming you didn’t know about the ten-year-old credit card because you don’t have it in your possession or your address has changed and you never received a new card, ask Chase to update your account and send you a new card for the old account.
• Ask the representative to add whatever your credit limit is on the new card to the credit limit on your old card. This way, your total available credit and your debt-to-credit ratio won’t be affected.
• Now you can close the younger card while potentially increasing your credit score. With one fewer young account, your credit history’s average age will increase.

Don’t give into temptation.

If you’re the kind of person who would use any credit card that still is valid, giving into temptation whether through a compulsion to spend or just a lack of self-control, the typical advice is to close the cards and take the hit to your credit score. This is a valid decision when cost of interest from overspending outweighs the chance of getting better interest rates on future credit.

This indicates a problem that extends beyond the use of credit cards. Spending compulsions or shopping addictions are concerns you should address independently of your credit card situation.

If you keep old cards active but cut them into pieces, you may be able to better control your spending. It’s only a small barrier, though. That won’t stop someone determined from using their cut-up credit card online — card numbers can be easily memorized.

It would be nice if we could design our financial lives to be free from the credit industry. Unless you meet one of the conditions I mentioned at the top of this article, keeping a high credit score should be a concern. Therefore, it pays — in concrete savings through better interest rates — to adopt these practices which can help ensure your credit score remains as high as possible.

Photo: Flickr

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This is a guest article by Lance, the founder of the blog Money Life and More. Earning rewards from credit card companies like cash back and sign-up bonuses, astute credit card users may be wondering how issuers afford to pay these bonuses for people who don’t pay interest or late fees. Lance takes a look at this feat.

Credit card companies have been offering some pretty awesome rewards and sign up bonuses recently. I personally have made almost $1,000 in credit card rewards last year, much of which came from sign-up bonuses. On top of that, I received cash back rewards from all of the credit cards I use on a regular basis.

Just so you can get an idea of some of the rewards I get, my Chase Freedom Card offers 1% cash back all of the time and 5% in categories that change every quarter (with a $1,500 spending cap). I have a Chase Sapphire Preferred Card that gives me 2% cash back on travel and dining and 1% cash back on everything else. It came with a 40,000 point sign up bonus after spending $3,000 in the first three months after opening my account. My last cash back card offers 1% on all purchases up to a spending limit of $10,000 a year and then pays out 1.5% cash back on everything else.

The credit card companies pay out a ton of money in rewards every year, but how do they pay for it? It helps to look at the problem of these reward programs from the credit card companies’ perspective before jumping right into how the credit card companies pay for it all.

The biggest potential problem about credit card rewards programs is that freeloaders take advantage of the offers.

Freeloaders

I am freeloader and I want you to be a freeloader too! If you aren’t a freeloader you absolutely should not be using these credit cards as they normally come with higher interest rates than a credit card without rewards. So what exactly is a freeloader?

A freeloader is someone who takes advantage of these credit card reward programs. They receive the awesome sign up bonuses and cash back offers that accompany the programs without providing any revenue for the credit card companies. Freeloaders always pay their balances off in full every month and never pay a dime (or even a penny) of interest. They never pay a late fee. They know their credit card rewards and fee schedules inside and out. They make sure they follow all the rules to never pay the credit card companies anything more than the purchase price of all of their transactions.

Some cards even have annual fees that are waived the first year. Most of these freeloaders will either get the fee waived in subsequent years or cancel their card. Some freeloaders won’t do this because the value of the rewards exceeds the annual fee, but I’d say the vast majority cancel or get the fee waived. They are freeloaders after all.

So if freeloaders exist, how do the credit card companies pay for the rewards?

Everyone else

If you have credit cards and you aren’t a freeloader then you’re paying the credit card companies (and the freeloaders) in one form or another. You could pay the annual fee, a late fee, a balance transfer fee, an over-limit fee, interest or any of the other fees and charges that credit card companies rely on for revenue. It doesn’t matter how the credit card companies get your money. The simple fact is they do get money from their customers and lots of it!

You must first meet many conditions in your credit card agreement in order to receive the rewards. Normally your account cannot be delinquent and you have to hit a certain points or cash back threshold before you can redeem your rewards. If you never meet those conditions you may never get paid those elusive rewards.

Consider these mind blowing statistics:

• The average APR on a credit card with a balance on it was 12.81% in November 2012 (http://www.federalreserve.gov/releases/g19/Current/)
• Total outstanding revolving debt was $850.8 billion. (http://www.federalreserve.gov/releases/g19/Current/)
• 56% of consumers have carried a balance within the last 12 months. (http://www.statisticbrain.com/credit-card-debt-statistics/)
• Only 40% of cardholders have credit card balances of less than $1,000. (http://www.statisticbrain.com/credit-card-debt-statistics/)

The interest that credit card companies collect could probably pay for all of the rewards multiple times over before you factor in any of the fees or other revenue sources.

Other major expenses of credit card companies

There are other expenses that credit card companies must deal with that possibly cause a much larger impact to their profits than paying rewards. Delinquent accounts are big headaches for credit card companies. If the companies never collect on a delinquent account they lose both the principal and interest owed to them for that account. The other option is to sell the account to a collections company for as low as pennies on the dollar.

Credit card fraud and identity theft are more big headaches for the credit card companies. I was a victim of credit card fraud myself. I thought I was lucky, and that the fraudster had only gotten away with a $19.95 order of Proactiv acne cream. Unfortunately I was wrong, and the issue expanded beyond just credit card fraud, and I was a victim of identity theft. The thief initiated a balance transfer for over $3,000, and if I hadn’t caught it as fast as I did the credit card company would likely have lost every penny of it.

One last thought

Credit card companies offer these stellar rewards programs for a reason. That reason is to bring in more customers and make more money! If they didn’t work, credit card companies wouldn’t offer them. How do I know that?

Credit card companies are businesses. They still make a ton of money after paying out the credit card rewards, covering delinquencies and writing off the charges made from cases of fraud and identity theft. Don’t feel bad for taking advantage of these rewards offers. If you can get the rewards and bonuses without paying the credit card companies a dime you’re doing great in my book.

Editor’s note. To expand on the above, credit card companies aren’t losing money by offering rewards, even when you consider just the freeloaders. Offering rewards encourages customers to spend more, and with every swipe of the card, the financial industry profits from interchange fees. The bottom line is that the money spent on marketing expenses, including sign-up bonuses and rewards expenses, are more than worthwhile. I can’t imagine a typical consumer is worried about how the credit card companies are able to generate profits when paying out $100 to $300 per rewards customer per year; this is a tiny expense for an industry with oversized profits.

Photo: Flickr

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