An Example Of Bad Credit Advice

I was reading this article about “How many credit cards are too many?” on the American Chronicle [noticed it earlier on Binary Dollar] and realized that it was actually dishing out advice that can hurt some people’s credit scores. It’s not a *horrible* article, but the problem is that it mixes good advice with bad. I have a feeling that such articles may be carrying a greater potential to confuse and mislead people than outright, easily identifiable, bad articles. Below, I have quoted some parts of the article and my commentary on the related issues.

The article starts like this:

Most Americans have between four and twelve credit cards in their pockets. There are also those who have even more rising up to twenty or more. Have you ever wondered how many credit cards are too many? How does the amount of credit cards you carry affect your credit report and score? Here are some thoughts about the subject.

So far it’s not that bad. However, it is clear that there are two separate issues under consideration here (I am not sure whether this was intentional mixture of two topics or just a result of a confusion).

Things get worse in the next section. Read this:

…However, more than 10 credit cards are completely unnecessary. Moreover, you should slowly replace your credit cards for credit cards with higher amount limits but you shouldn’t keep the previous ones. And you should only do this if you can afford it and your debt to income ratio doesn’t suffer that much.

Agreed, 10 credit cards are *unnecessary* (btw, I have 9! …for various reasons, including early ignorance). But the next two sentences just don’t make any sense. Apply for higher amount limits..but DO NOT cancel the other cards. You must retain your older cards or else suffer major dings to your credit score (well unless you are paying annual fees or something to maintain a junk card).

Also, it’s not the “debt to income” ratio that is influenced by opening new (higher) lines of credit; it’s the outstanding balances to credit-line ratio (often called as credit utilization) that is affected. Debt to income ratio depends on outstanding balances and your income and that’s got nothing to do with credit utilization.

This “debt to income” confusion keeps happening throughout the article. For example:

What is really important is to maintain your credit card balances within a reasonable range so income to debt ratio (and consequently your credit score) won’t suffer.

Again, credit score (at least the FICO score) does not depend on debt to income ratio (check your credit report and see if your income is reported anywhere on it…it’s never reported). It depends on credit utilization.

A hypothetical person with a million dollar income and $500 debt (very low debt to income ratio) can have trashy credit scores if he/she has defaulted on payments.

There may be other scores that take into account the debt to income ratio, but I don’t know of any and I don’t know who uses those scores if at all they exist. However, since FICO scores are the most popular ones, I prefer to talk in terms of FICO scores.

The confusion just never stops. Later in the article, this comes up:

…This is due to the fact that even if you always pay the minimum payments on your credit cards, too much debt accumulated makes lenders doubt your ability to repay further debt. That’s the main reason why a low income to debt ratio will lower your credit score even if there are no delinquencies on your credit report.

While it is true that some lenders may look at your debt to income ratio and make judgments on your repayment capabilities based on that ratio….it is not true that a low debt to income ratio lowers your credit score. Btw, did you notice how the article suddenly mentions “income to debt ratio” instead of “debt to income ratio”? …more scope for confusion there.

Now comes the real juicy (crappy (?)) part. Don’t just read it…enjoy it :

Thus, you should be very careful with the amount of credit cards you hold and always consider that having too many open lines of credit can scare away future lenders that you may need. Thus, if you don’t really use them, if you just have them because they were offered for free, you should close them.

But don’t close all your accounts at the same time because this will affect your credit too. Instead, slowly replace the credit cards you actually use with those with the lowest APR and the highest credit limit possible according to your needs, closing at the same time, those with the highest APR even if they offer exceptional credit limits.

This is incredible. Three things - two bad advices and one lack of good advice. 1. it says you should close your unused accounts, and 2. it says close the ones with highest APRs even if they offer good credit limits. 3. It does not mention anything about the importance of the “age” of your credit history or the importance of your old credit cards on your credit file.

If you close your unused accounts, it will hurt your credit score. Now, how badly it will hurt depends on which credit card to cancel. If you cancel the oldest one, you will do major damage to your credit score. It doesn’t matter if it has 350% APR. If the high APR bothers you, don’t use the card (or always pay it in full), but DON’T cancel it if it’s your oldest cards (or one of the older cards). Moreover, if you close a credit card with a high credit limit, that will just make your credit utilization even worse and further damage your credit score.

The article did give one good advice, but it was all overshadowed with the rest of the crap. Here is the good part:

The idea is that the number of credit cards is not so important. What is really important is the amount of money you owe on them. Ten credit cards with the balance on zero all the time because you don’t finance your purchases and you use them just to avoid carrying cash, won’t alter your credit in a negative way and chances are that your credit history will benefit from such procedure. But accumulating high balances on your credit cards will definitely affect your credit score negatively and scare away new creditors.

That should have been the concluding thought of the article. What matters most (after on-time payments) is your credit utilization. Now, credit utilization DOES NOT depend on the number of credit cards you have. You can have horrible credit utilization (and hence a horrible score) with just one card or excellent utilization (and hence excellent score) with 10 cards.

I think the author of the article was completely confused between two distinct issues here: 1. Number of credit cards, and 2. Credit utilization. Now, if you are confused by all this, here is a quick summary for you:

• Don’t confuse between debt-to-income ratio and credit utilization. They are not related to each other. Only credit utilization influences your credit scores and not the debt-to-income ratio.
• It is OK to have open and unused lines of credit (however, if you don’t use a credit card for a long time, there is a chance that your card issuing company may cancel it…so swipe the unused cards every once in a while).
• DO NOT close old credit cards in an attempt to manipulate credit utilization. It will hurt your score. Open new accounts (just one or two in a couple of years) if you want, but never cancel your old accounts.
• There is one chance where the “number of credit cards” can hurt you…and that’s when you apply for too many credit cards in a short span of time. Again, technically it’s the number of open credit inquiries that will hurt your score - not the number of credit cards. Once those inquiries disappear from your credit report (after two years) …your score should potentially come back to normal, even with the increased number of credit cards.
• If you don’t digest all this after reading it once, read it again, or feel free to ask questions ..but make sure you understand it all.
• Finally, never rely on just one source of information. Always get a second (sometimes third or fourth) opinion.

Related posts and resources:

• Here is an earlier post by me on this subject: How Many Cards Does It Take To Hurt Your Credit Score?

• Intro to Credit Gaming - Part II @ Gaming the Credit System.

• Top 10 Credit Mistakes @ Credit.com

• Anatomy of a Credit Score @ MSN Money