Should I Tear Apart My $300 Limit Credit Card - The Worst Credit Card Ever?

(May 4th, 2007)

debt consolidation questionDear 3DebtConsolidation.com:

I was in a financial crisis in the earlier stages of my life that pretty much ruined my credit. In an effort to rebuild my credit history, i took out a $300 limit credit card that has a $6.50 monthly fee and an Annual usage fee of $150. The interest rate charged on this credit card was a whopping 25%! I want to cancel this credit card immediately, but if I do this, my credit score will be negatively impacted? Remember, the point of me taking out this credit card is to rebuild my credit history! My question therefore is, should I cancel the card immediately, or wait till its fully paid off and then cancel this? How will my credit score be affected under both of these scenarios?

Dear Stephen:

Consider your scenario to that of a dating relationship where the other party is costing you a lot of money, and you are going nowhere with the relationship. Would you still continue on with it? Definitely not! Apply the same analogy to your situation and you will know the answer!

The type of credit card that you are stuck with (the $300 limit credit card) is known as a "Sub-Prime Credit Card." Sub-Prime credit cards carry huge hefty annual fees with ripoff style interest rates. I assume the $150 annual fee is taken directly from your credit card, essentially lowering the credit limit you have available from $300 to $150 ($300 - $150 fee). These types of credit cards are not really meant to help the borrower establish his credit, they are more like payday loans where the lender is trying to make a quick buck. Thus, you should immediately terminate the credit card and stop using it!

A better option for people like yourself trying to establish a good credit history is a low or no-fee secured credit card. This secured credit card is attached to your Savings account, and the balance in your Savings is pledged as collateral. Thus, if you go broke, the credit card lender can withdraw the amount from your savings to recover his loss. In order to establish a good credit history with secured credit cards, treat them just like unsecured credit cards. Make necessary purchases with them (such as grocery items) and pay them off before the grace period ends. Once you make regular on-time monthly payments for a few months, credit card lenders will like your creditworthiness and offer you a higher credit limit, with lower interest rates.

A topic related to the question you asked is, how can someone go about improving his credit score? Here are some guidelines derived from our article on How to Improve Your Credit Score - 4 Basic Things.

1) Pay Off Your Debts

To get good mortgage loan terms, you need to have a credit score in the 700 - 720 range. The expected national average is 723 according to Fair Isaac. What's the best way to increase your credit score in the short term? The best way is to pay off any high debt balances on your credit cards which could increase your credit score by a whopping 60 - 80 points overnight! Credit Bureaus look at how you handle credit card debt, whether you try to pay it off as fast as you can, or you are the type of person that only meets the minimum payment schedule. If you are determined to pay off your high credit card balance, this will reflect on your credit score and will net you favourable terms with mortgage lenders.

2) Never Use More than 50% Of Your Credit Limit

If you spend more than 50% of your credit limit every month, this indicates to the Credit Bureau that you do NOT have enough cash on hand to meet your monthly expenses. This will term you as a high credit risk and will actually reduce your credit score by 60 - 70 points overnight (according to Craig Watts working at Fair Isaac). You need to minimize your credit limit usage and keep your credit balances owed very low for atleast 3 months before applying for credit or a mortgage loan.

3) Don't Close Old Credit Cards

In the above bulleted list, we mentioned "Time Length of Credit History." If you have credit cards that are 4-5 years older, then it's NOT a good idea to close them down. Use those to maintain your credit history and use them responsibly! Furthermore, do NOT go out applying for new lines of credit at any retail store or bank, and do not go out asking for an auto loan, because that will decrease your credit score by a few points instantly.

4) Ordering Your Credit Report or Seeking Credit Counseling

Here are some myths that do NOT affect your credit score in any way.

  • You ordering your credit report from Experian, TransUnion or Equifax.
  • You going out to seek credit counseling or debt management services.
  • Mortgage or other debt lenders checking your credit score for any applications you have made.