credit cards

I often wonder about the irony of subprime lending - whether it’s made available through mortgage or through credit cards or through any other source of credit. I mean, people with bad credit are the very people who should be staying away from subprime borrowing. These people are already in the subprime category because of financial troubles and then there are these stupid (and very likely, unaffordable) subprime products targeted at them - which have the potential to throw them deeper down the financial hole.

Here is one such stupid subprime product - the Continental Finance MasterCard. It’s hard to believe that this piece of plastic comes with an initial credit limit of just $53 after a long list of fees!

Below are some of the amazing rates and fees that go along with this card.

• Account setup fee: $99

• Program participation fee: $89

• Annual fee: $49

• Account maintenance fee: $120 (charged @ $10/month)

• Purchase APR: 19.92%

• Authorized user fee: $30 (great! seems like $53 credit is a bit too much for a single person to handle)

• Credit limit increase fee: $25 (and you don’t even have to ask for it!)

Each Credit Limit increase will be $100.00, subject to a maximum Credit Limit of $2,000.00. Each increase will appear on your Account no later than one (1) month after you have qualified for such increase. At the time of each Credit Limit increase, a $25.00 Credit Limit Increase Fee, which is a FINANCE CHARGE, will be charged to your Account.

You need to call these people and ask them to stop; otherwise, they are automatically going to increase the limit by $100 each time and charge you the $25 fee.

• Internet payment fee: $4 for each authorized internet payment. I just don’t get this - why are people with bad credit charged for paying their bills online? .. probably to make sure that they don’t start paying their bills automatically or something?

And, here is how the $53 initial credit limit appears:

Your initial Credit Limit will be $300.00 and you agree to pay the following fees, which will be billed to your Account and will appear on your first monthly Billing Statement: a one-time Account Processing Fee of $99.00, a one-time Program Participation Fee of $89.00, a monthly Account Maintenance Fee of $10.00 and an Annual Fee of $49.00. Your available credit after these charges will be $53.00 at Card issuance.

Here is an YouTube video that points fingers at this same credit card for some of the reasons mentioned above:

[youtube]FunpS4QXcRI[/youtube]
[Feed readers click on this link to watch the video.]I agree that people with bad credit pose the risk of potential losses for the credit issuing company, but this a bit too much for a credit line worth just $300. This is where the irony strikes me - if you make it difficult for people to pay back what they borrow, it’s only going to increase the chances that they will never pay back what they borrowed. Isn’t there a risk assigned to this perspective?

If it’s so much risk then don’t issue credit cards to people with bad credit (I have similar thoughts with regards to subprime mortgage - it’s a self-inflicted disaster on part of both, lenders and borrowers). Just offer secured credit cards and lend against a collateral.

By the way, there is another not-so-obvious trap hidden in such credit cards for people with bad credit. If you apply for a particularly horrible “bad credit” credit card and start building your credit history with this card, then some time down the line, when you think you have built sufficient credit and no longer need this horrible card, you are going to face a problem - your credit history is going to take a hit if you close this account. And, if you don’t close it down, the annual fees are going to create a leak in your pocket for quite some time to come.

So much for the cost of bad credit and so much for people with bad credit wanting a credit card (which creates the demand for such products in the first place).

If we ever have a competition for the worst credit card in the world, do you know some good competitors for the one I mentioned above?

After a year long run with 0% APR credit card arbitrages, it looks like it’s time to pull the plug.

The sole reason for ending this free money run is the lack of *good* 0% APR offers to continue transferring the existing balances. Most credit card companies now impose balance transfer fees at about 3% of the amount of the balance transfered with no maximum limit and some have taken the “0% APR” terminology totally off their charts. All in all, the card companies seem to be making sure that people don’t milk them for the money with these offers.

In my case, some additional crap happened which has sort of ticked me off this arbitrage game. Here is how stuff unfolded:

• Currently, I have balances on Citibank and Discover cards. The offers are coming to an end within the next few weeks.

• Balance transfer offers do not allow transfer between two cards of the same kind (you cannot use a balance transfer offer to move your balance on one Citibank card to another Citibank card). So, I tried applying for a third party credit card (HSBC - 0% APR with balance transfer fees) and that got approved with extremely low credit limit and made it totally worthless - the net gain after taking taxes and fees is hardly worth the trouble.

• Then, a few minutes later, I tried applying for a Discover card (Discover More Card) so that I can transfer the balance from the Citibank card. This application got rejected! Interestingly, I was chatting with their service professional through a live-chat service at the time of the application and she got back to me within seconds after I submitted the application informing me that it was declined. From the promptness of the decision, it was pretty obvious that it was rejected through some “automatic” criteria without any human intervention. My current credit score is 742 (which is not bad), so it had to be some other stupid reason on which they based their decision.

• Then, after another few minutes, I tried applying for a Citibank card (AT&T Universal Card) so that I can transfer the balance from the existing Discover card. This card was approved, but again with a very low credit limit. Crap! so even this didn’t work out.

• At the end of all this, I ended up with one rejected application and two useless credit cards and no feasible solution to transfer the existing balances.

It was more crap than I could handle peacefully and I decided to put an end to the misery by just paying off all the balances. Will keep an eye out for good offers in future.

By the way, a few days later, I received a letter explaining why my application for the Discover card was rejected and this it what it listed as the reason:

Credit History Established On Your Account

What’s that supposed to mean? It sounds incomplete to me.

~*~

Anyways, here is some more information on how credit card companies currently deal with 0% APR balance transfer offers. I had to go through all this before applying for new cards. Although, there are a lot of players in this area, I am just including the big ones.

• Discover: Charges a balance transfer fee of 3% with a minimum of $5 and maximum of $75 (in some cases the maximum is $50). With the upper limit still in place, Discover cards with very high credit limits are still attractive - although not as attractive as before (you will still lose a small percent of the free money in fees). 12 month offers are standard.

If you get a $10,000 credit limit and transfer the entire amount and park it in an online savings account at 5.15% APY, your earnings before tax would be $515. After tax (assume 25% bracket) it would be about $386. After accounting for the balance transfer fee, you will have about $311 in your hand. That’s a pretty sizable amount; however, there are a few caveats.

From personal experience, Discover is pretty stingy with their credit limits. Plus, it has another new trick up it’s sleeve. According to their updated terms and conditions:

If more than 90% of your New Balance consists of special rate balance transfers, we may increase your Minimum Payment Due to a maximum of 4% of the New Balance..

Increased minimum payments are going to further erode your earnings.

• Citibank: They have at least one no-fee 0% APR balance transfer offer on charts (AT&T Universal Card - not a referral link) that I know of (perhaps there are one or two more, but there sure aren’t many). So, if you are interested (and lucky enough to get a good credit limit), you may try this one out. Other than this particular offer, Citibank charges a 3% balance transfer fee with $5 minimum and no maximum. 12 months offer period is typical.
  

Cards with no maximum on balance transfer fees are not attractive enough for playing the arbitrage game. I wrote about this earlier when Citibank sent me the change of terms notice.

• American Express: Typically, they charge a balance transfer fee of 3% with $5 minimum and $99 maximum. Plus, currently these guys don’t even have any 0% APR offers; the best they can do is a 4.99% APR on transfered balances till they are paid off.

If you get an AMEX card approved for less than $3300 of credit limit, your effective expense on the balance transfer will be 7.99%. There is no way that can be offset with a high yield online savings account (or any other place where your park cash will have sufficient liquidity and guaranteed returns). With a credit limit as high as $19,800, you are still looking at an expense of 5.49%.

That takes American Express totally out of the arbitrage game.

• Chase: Read offers terms for Chase cards carefully. Their balance transfer offers are of 12 months, 6 months, or 3 months duration depending on how “favorably” they view your credit history. For example, here is a typical clause in their terms:

Elite and Premium Pricing: A 0% fixed APR for the first 6 billing cycles following the opening of your account… Standard Pricing: A 0% fixed APR for the first 3 billing cycles following the opening of your account.

Generally, balance transfer fee is 3% with $75 maximum.

Personally, I am not a fan of short term balance transfer offers - the gains are not much and you will need to look for another credit card pretty soon. Plus, I didn’t apply for Chase card after my experience above because I didn’t want to end up with another useless credit card with extremely low credit limit and 3 months offer period. That will simply put another card on my credit history without doing me any good.

• Bank of America: Charges a 3% balance transfer fee with $10 minimum and no maximum. Unlike for the case of Citibank (where there are a few exceptions to their balance transfer fee policy), Bank of America’s balance transfer fee is applicable to ALL the cards it has to offer. So don’t waste your time looking for credit card offers from these people.

• HSBC: These guys have a few good 0% APR cards still available. If I understand their terms and conditions correctly, they imply that HSBC Bank customers will not have a balance transfer fee on the cards for the initial offers, whereas non-HSBC customers will have a 3% transfer fee with $99 maximum. Make sure you read their terms and conditions very carefully. Offer term may be 6 months or 12 months depending on which card you apply for.

Dave Ramsey is going to be happy with me for writing this post.

Normally, I don’t subscribe to Ramsey’s psychology and I don’t recommend cutting up credit cards (at least not valid, unexpired ones that can still be used). But, I was just re-reading one of my long-time favorite books “Physics for Entertainment” and suddenly thought of using credit cards for one of the *entertaining* experiments suggested in the book [credit card plastic is rigid and virtually indestructible and hence a good candidate].

Before I proceed, let me make a few comments about the book - I am not sure how many of you have even heard about it. The book, first published in mid-90s, comes in a two part series, and was originally written in Russian by Yakov Perelman. Both parts of the book are extremely rare to find in the present times. The only place that still has it (that too only Part 2) is Alibris.com - with a price tag of $130. Interestingly, about 15 years ago, my dad bought the book (both parts included - *used* condition) for some measure of currency that is equivalent to about 25 cents (US $) in today’s world.

Anyways, back to the credit card boomerang thing.

First, it will be helpful if you read up this information on boomerang basics. After you read that, it will be obvious that we are looking to create some L-shaped flying objects from the credit cards. Technically, we are tying to make a “returning boomerang”.

This is easier when explained with images, so here are before-and-after images of boomerangs made out of a Sears Gold Mastercard (that card was still valid when I cut it up - didn’t have any expired credit cards):

To avoid being unfair to credit cards, I also cut up a check card (no more ATM fees ):

Now, to fly those boomerangs, follow these instructions:

It takes a bit of a practice before you will get it right (here, some people may realize that they can’t even flick properly). Also, you could try testing boomerangs of various shapes - try twisting them a little bit (helps for a longer flight), try rounding off the corners, etc. - additional incentives to cut up more cards.

A good L-shaped credit card boomerang should fly up to 10~15 feet and will *almost* come back to you.

Additional tips:

• It’s OK to have two arms of unequal lengths - in fact, that way it might work even better.

• They are fun to play with, but be careful - a good boomerang will come back to you and you don’t want it to get in your eyes. Credit card plastic is very hard (that’s why it works well in the first place), and it can really hurt if it gets in your eyes (or someone else’s eyes). So watch you kids if they are cutting up your credit cards for fun.

• In addition to teaching your kids how to cut credit cards, you can also try explaining some science to them. That will make your card cutting activity a bit productive.

So go ahead… check out if Mastercard flies better than Visa, or Amex.

OK people, bring it on. Let’s throw some arguments from both sides of the table and discuss this issue.

I have got more than one reader say something to this effect:

What’s dumb about credit cards? There’s no emotional connection when using plastic. If you go to Lowe’s with a credit card vs. cash, studies indicate you are going to spend far more money using the card. Multiply that by all the transactions you do on plastic and you’ve got a lifetime of overspending. Most people think they’re the exception to this rule, but there’s a reason the retailers happily shell out tons of money to have those little card processing boxes on the counter - gross sales go through the roof. Ask McDonald’s.

Here are some sparks to start the fire:

• Is the above comment a sound rationale against not using credit cards? or is that just masking one’s personal inability to understand/use credit cards properly?

• Is debt due to credit cards or is it due to the lack of proper knowledge about handling credit cards?

• Why do you (or don’t you) use credit cards? Emotional reasons or practical ones?
  

• Be good to plastic (use it properly) and it will be good to you?

• Rewards are a ripoff? or are they blessings for those who can use cards in a proper manner?

Don’t restrict your comments to the above questions ~ feel free to add any input you have got on this topic. Now, I could just cite some articles that argue either ways, but I want hear it from my readers.

For those who love credit cards for various reasons, here is your chance to defend your plastic.

You can be as critical as you want - so long as you don’t get personal. No name-calling please.

You can keep a track of subsequent comments on this post by checking the “subscribe to comments” box near the “submit” button in the comment box.

I was reading up some articles at CBS News, and came up on this interesting one: Meet “Generation Plastic”. It’s about students who get caught up with credit card debt. Apart from some sad stuff about credit card marketing strategies, there is something else to notice in the article. Read this:

“I had Visa, Visa MasterCard, First Financial Bank, Visa, Gap, Target” says college senior Sara Magee. She was lured at 18 by the promise of a free Frisbee. A dozen credit cards later, she’s working three jobs to pay down $6,000 in charges, fees and interest.

“I didn’t understand interest and what a high APR was — I really just didn’t understand the concept, and it seemed like a good idea — like (I) can’t afford it now, but I will pay it off later,” she says.

This comes from a graduating senior!

I am pretty sure there are a whole lot of students in the same boat - and of course, there must be a whole lot of non-students who know diddly-squat about credit cards, their usage, and related terminology.

When you don’t know what “APR” is, how much it will cost you in interest, what are the consequences of late payments, etc. - and you still keep swiping it around as much as you can; then you are basically the guy in this picture (been there, done that):

Now, blaming credit card companies for high fees, twisted marketing tactics, and unfair billing practices is all meaningful - only AFTER we, on our part, take enough efforts to understand how these things work. The way I see it, most pain and suffering caused by credit cards is initiated due to credit card abuse by the consumer. This pain is then compounded by credit card companies’ tactics.

To solve part of the problem, here is an outrageous suggestion: impose a card-specific, knowledge-based test to determine whether a person is eligible for *using* a credit card. A credit card application won’t go through unless all the questions are answered correctly. Such tests should include simple questions like:

• What does APR stand for?

• What is the grace period on the card for which you are applying?

• What will be your APR if you miss one payment?

…and some moderately challenging questions like these (moderately challenging = something that a monkey will not be able to answer easily):

• What will be the minimum payment due if you carry a balance of $5000 during the statement period?

• At 14% APR, how much would it take for you to pay off $1000 balance on your credit card if you keep making minimum payments?

Feel free to thrown in suggestions for questions that you think should be part of such a test. Sarcastic suggestions are perfectly OK.

This will serve some good purposes like:

• The extra hassle will discourage casual credit card seekers - and it will enforce awareness for those who seriously want to have a card.

• It (the numbers) will make people think twice before applying for a relatively *bad* credit card.

• Even if people cheat on such tests, they will be forced to look up (or ask for) some information - which would still serve the purpose of raising awareness.

Yeah people will whine and moan - but that exactly would be the purpose of such a test - to make them whine and moan before they get their credit cards instead of after using them mindlessly.

For students, there should be a “Credit Cards 101″ course…and they should not be allowed to apply for a card unless they have taken that course. It will be interesting to see how many students just give up on credit cards just because they want to avoid the course.

“You are pre-approved” will have a radically different meaning.

Any other novel preventive measures or suggestions for refinement? (”ban credit cards” is not creative enough)

Some amount of sarcasm is intended (more than a solution to any specific problems) through this post. The aim is to channel our thinking towards how to make (force) people understand credit cards before they start using it foolishly. The qualifying test is just one potential hypothetical measure ~ to be taken with a grain of salt. One can easily fathom the enormous social effort that will be required if such a system were to be practically implemented.

According to PBS Frontline, the term “deadbeat” is commonly used in the credit card industry in the following sense:

“Deadbeat:” Although “deadbeat” normally means “one who does not pay one’s debts,” [Source], the word has taken on a new meaning for credit card companies. For them, “deadbeat” means someone who avoids interest and fees by paying her/his account balance in full each month rather than paying the minimum amount and carrying a balance. Credit card companies do not earn much from these cardholders. About 55 million Americans pay their bills in full each month.

Now, let’s see why it can be tough.

Here is a snapshot of a part of our bank account summary after the first week of this month:

It shows the payments we have made to credit card companies early this month. The sum of all those payments comes to $3753.66. Without getting into details about our student salaries, let me convey our feelings about these payments in a concise manner: OUCH!

A few payments went towards credit cards carrying 0% APR balances, but most went towards cards that had purchasing charges (we charged some big ticket *needed* items on credit cards last month). Although unpleasant, the *ouch-factor* didn’t unsettle us too much because most of the expenses were anticipated…some of them were budgeted, and rest will be *post-budgeted* in the months to come (I will talk about our concept of *post-budgeting* in different post in future). There was also some digging into emergency funds.

It’s tough to part with that kind of money at once, but after my insightful fight against debt in the past, I have developed a habit of paying off the entire balance on all the credit cards at the end of the month (or within the first couple of days in the following month), irrespective of whether the due date is near or not, and irrespective of whether the statement is ready or not. As a result, our purchase balances on all credit cards are reset to zero at the start of every month. Since this habit, I don’t remember the last time we paid interest to credit card companies. Of course this paying-entire-balance stuff does not apply to the 0% APR balances (those balances don’t cost us anything).

So yeah, it was hard and all, but as they say - you got to do what you go to do…and we want to be deadbeats for the rest of our lives, so that’s what we got to do.

Feels good to be among the 55 millions folks who don’t get much love from credit card companies.

Are you a deadbeat too? Do you have (or had) a tough time being one?

That’s a part of my junk mail pile (neatly arranged) from the last few weeks. Finally, after much procrastination (as usual), I got to shredding the damned things yesterday. This time, I documented the rogue mail senders, so that I can systematically hate them according to how much junk they send me. Here are the results:

Chase was the undisputed winner in our little junk mail contest. With 27 letters - some pre-approved offers and some of those stupid $10 checks - in a span of about 3 weeks, the king of junk mail seemed to be hell-bent on ruining our cheap paper shredder.

Bank of America, Citibank, and Discover also sent some junk to our mailbox, but they don’t come anywhere close to Chase. However, Citibank and Discover still managed to aggravate the shredder by sending over-sized junk mails. Verizon didn’t really send *financial* junk, but I included it nevertheless since it ranked among the top 6 contenders. It should be noted that these junk mail numbers do not include pieces of mail that carried genuine financial information like transaction summaries, changes to account terms and conditions, etc.

Junk mails are not just trivial irritants, they are a burden on a lot of resources - precious paper, time, peace of mind, and shredding machines. Plus, there is that ever-increasing risk of identity theft. I just don’t understand these companies; on one hand they have started encouraging paperless billing for increased security and reduction in paper usage, and on the other hand they just keep dishing out these junk letters which ironically invalidate the very advantages of paperless billing.

I did try to stop this nonsense sometime back. I remember registering with OptOutPreescreen.com (if you want to get rid of those unsolicited *pre-approved* offers, this is the place to go…supposedly) a few years ago and observed a decline soon after that (perhaps it was just a coincidence), but things are gradually back to the earlier junk status.

Apparently, using OptOutPrescreen.com does not eliminate all junk mail. In their FAQs they mention something to that effect.

I’ve submitted Opt-Out requests through this website and to the Direct Mail Association (DMA), but I’m still receiving offers.
Opting-Out will not end solicitations from all local merchants, religious and charitable associations, professional and alumni associations, politicians, and companies with which you conduct business. To eliminate mail from these groups - as well as mail addressed to “occupant” or “resident” - write directly to each source.

Ok, so I am getting all this spam from “companies with which you conduct business“. Seems like I will have to get on the phone with Chase regarding this.

Btw, for those who want to cut out all the crap, there is something else you should do in addition to registering with OptOutPrescreen.com; register with Direct Marketing Association’s “Mail Preference Service” (there is a $1 fee for this!). The website doesn’t appear professional and/or *pretty*, but it is a legit place to get rid of some pesky advertisements. However, even this does not guarantee a junk free life.

Although the typical consumer sees a great reduction in the unsolicited mail he or she receives not all commercial mail will stop. You will continue to receive mail from companies with which you already do business and from non-DMA member companies that do not use our service. In addition, you may continue to receive mail from local merchants, professional and alumni associations, political candidates and office holders, and mail addressed to “resident/occupant.”

So you could try all you want with those two stop-junk portals, but basically it seems like you will still need more than a few hours and more than a dozen phone calls to stop all that junk mail after all.

Need to rant about your junk mail troubles? Feel free to leave a comment.

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

What do the credit card numbers mean and how are they generated? I need to start with a disclaimer: Do not use any credit card numbers, except your own, to buy things off internet. It’s wrong and it’s illegal. The purpose of this post is *not* to create fraudulent workable card numbers. It is to explain the math and the science behind those numbers that most of us see day in and day out; and hence this post should be viewed from a purely academic perspective.

Typical credit card anatomy

Before we understand how credit card numbers are generated, here is a brief explanation of what a typical credit card number means.

• Out of the 16 numbers on a typical credit card, the set of first 6 digits is known as the issuer identifier number (read this for details), and the last digit is known as the “check digit” which is generated in such a way as to satisfy a certain condition (the Luhn or Mod 10 check). “Luhn check” is explained later in this post. The term sounds intimidating, but it’s really a very simple (and elegant) concept.
• Taking away the 6 identifier digits and 1 check digit leaves us with 9 digits in the middle that form the “account number”.
• Now, there are 10 possible numbers (from 0 to 9) that can be arranged in these 9 places. This gives rise to 10⁹ combinations, that is, 1 billion possible account numbers (per issuer identifier).
• With each account number, there is always an unique check digit associated (for a given issuer identifier and an account number, there cannot be more than one correct check digit)
• Amex issues credit cards with15 digits. The account numbers in this case are 8 digit long.

What is the “Luhn” or “Mod 10″ check?

In 1954, Hans Luhn of IBM proposed an algorithm to be used as a validity criterion for a given set of numbers. Almost all credit card numbers are generated following this validity criterion…also called as the Luhn check or the Mod 10 check. It goes without saying that the Luhn check is also used to verify a given existing card number. If a credit card number does not satisfy this check, it is not a valid number. For a 16 digit credit card number, the Luhn check can be described as follows:

1. Starting with the check digit, double the value of every second digit (never double the check digit). For example, in a 16 digit credit card number, double the 15th, 13th, 11th, 9th…digits (digits in odd places). In all, you will need to double eight digits.
2. If doubling of a number results in a two digit number, add up the digits to get a single digit number. This will result in eight single digit numbers.
3. Now, replace the digits in the odd places (in the original credit card number) with these new single digit numbers to get a new 16 digit number.
4. Add up all the digits in this new number. If the final total is perfectly divisible by 10, then the credit card number is valid (Luhn check is satisfied), else it is invalid.

When credit card numbers are generated, the same steps are followed with one minor change. First, the issuer identifier and account numbers are assigned (issuer numbers are fixed for a given financial institution, whereas the account numbers are randomly allocated - I think). Then, the check digit is assumed to be some variable, say X. After this, the above steps are followed, and during the last step, X is chosen in such a way that it satisfies the Luhn check.

This part is a bit confusing and takes some time to understand. However, don’t get stuck here…continue reading through the examples below and you will figure out what this is all about.

Credit card numbers valid or invalid?

Have you ever wondered if those numbers on the fake plastic or cardboard credit cards that come with the “preapproved” offers are real or imaginary? If they are not valid, how do you know it?…Just apply the Luhn check and all the those fake credit cards will invariably fail.Here is an example of a VISA credit card (look at the expiry date - 01/09 ..it’s still valid ! )

Note that the credit card number starts with “4″…so it is indeed a VISA issued credit card (VISA cards start with “4″ and MasterCard/Maestro cards start with “5″). Now, let us apply the Luhn algorithm to this card. To make it easier on you guys, I have created a schematic of the steps towards the Luhn check (below) for this card number 4552 7204 1234 5678:

• In this case, when we sum up the total, it comes to 61 which is not perfectly divisible by 10, and hence this credit card number is invalid.
• If such a credit card number is ever generated, the value of the check digit would be adjusted in such a way as to satisfy the Luhn condition. In this case, the only value of the check digit, that will create a valid credit card number, is 7. Choosing 7 as the check digit will bring the total to 60 (which is perfectly divisible by 10) and the Luhn condition will be satisfied. So the valid credit card number will be 4552 7204 1234 5677.

Let’s try another example, this time with a MasterCard.

Again, performing the Luhn check on this credit card number, we have:

• The total comes to 65 which is not perfectly divisible by 10. Hence this credit card number is invalid.
• In this case, a valid credit card number will result only if the check digit is 8. This will bring the total to 70 which is perfectly divisible by 10. So the valid credit card number will be 5490 1234 5678 9128.

Closing remarks

If I still have your attention, here are some additional thoughts. In the context of this post, by the term “valid”, I mean “mathematically valid”. A mathematically valid credit card does not mean a “working” credit card. The Luhn formula validates only the credit card number; it does not validate the expiry date and/or card security code (CVV, CVC). Plus, as discussed before, the 9 digit account number will yield 1 billion combinations; so the chances of getting a working credit card number are very remote. It should also be noted that, this validation is usually employed at the transaction end; which means that numbers that do not satisfy the Luhn check are not forwarded to the card issuer and the transaction is terminated. If you have a fake credit card which satisfies the Luhn check, it will go through at the transaction end, but the card issuer will most likely catch the mischief. So don’t go about trying to use these numbers to buy stuff.

Just to be clear on this, I don’t expect comments like these (check out the source of this comment):

hey. im hearing good things about your site! i need some money to jump start my poker career. Probably about 40-100$ would do. i dont have a credit card to use and it pisses me off because i know i could beat the majority of the people online. please help

If you intend to post such comments, at least be extremely funny.

So you think you can separate out valid and invalid account numbers now? Here are a couple of trial numbers for you:

• 5491 9469 1544 4923 - Valid or invalid? If invalid, what should have been the correct check digit to make it valid?
• 4539 9920 4349 1562 - Valid or invalid? If invalid, what should have been the correct check digit to make it valid?

Sudoku fans will quickly figure out multiple valid combinations of the above numbers. If you don’t want to do the math, here are some ready made valid (”test”) credit card numbers from Paypal.By the way, the Luhn check is also valid for debit card numbers.I am still in the learning phase with this topic and trying to further understand how people use (or misuse (?)) such information. If you have some insight in this matter, please feel free to share it with us.If you liked what you read above, go ahead and subscribe to this blog to get more updates. It’s easy - just click on one of the buttons below and get the feed.

Resources and References

There is a vast amount of literature on the Luhn algorithm and a quick Google search will enlighten you on how popular this topic is. If you don’t want to read all that, here are links to some interesting reading.

• Card Identification Features (pdf file) - extremely useful, must read.
• Credit Card Numbers and Credit Card Generator @ Graham King.
• Anatomy of Credit Card Numbers.
• Credit Card Number - Wikipedia.

VISA card image source: http://www.hkuaa.org.hk, MasterCard image source: http://www.nscs.org