When I was younger and dumber I racked up a lot of credit card debt. I’ve got a bunch of cards, ranging in limits from $3k to $20k. Now I’m making some money and paying down the debt. I don’t want to be tempted to get into this kind of debt again. Is it better to close the credit card accounts once I pay them off or is it possible to just lower the limit on the card?
It’s good that you’ve worked out your budget and are now paying off your credit card debt. Credit cards usually have high interest rates so paying them off will both reduce your monthly expenses and improve your credit score.
You may find it useful to read this earlier post on paying down credit cards and ways to speed up the process. Taking out a line of credit at a lower interest rate to pay off your credit card balance can save you money in the long run.
As to whether it is better to close your credit card accounts or reduce the limit of your cards (lowering limits is indeed an option), let’s look at some pros and cons.
If you were to close your credit card accounts the main benefit would be that there is no longer longer a temptation to spend money on the cards. When you have no credit card account you don’t have the option of going into credit card debt. That is probably the only positive outcome if you close your accounts once they’re paid off.
On the negative side, closing your credit card accounts will reduce your credit score. You’ll no longer have a good credit utilization-to-limit ratio when the accounts are closed and you’ll lose the benefit of the credit history you’re currently building. Also on the negative side, you won’t have any wiggle room if your savings dry up. Being in credit card debt is bad, but it is often a better alternative to not being able to buy things you need in an emergency.
You may also find, especially if you travel, that a lot of places require a credit card to reserve hotel rooms, book taxis, and buy airline tickets online. Online shopping also becomes a lot harder if you don’t have a credit card.
Now, let’s look at the pros and cons if you decide to keep your credit cards, but just lower your spending limit. On the negative side you’ll still have the cards and may be tempted to spend money on them. The lower limit will reduce the potential damage, but the ability to rack up a little debt will still be there. Lowering your limit will also slightly reduce your credit score because your ratio of credit usage to credit limit will be lower. This will be a minor impact, but something to consider.
On the positive side of things, having a few credit cards with low limits helps you in a few ways. As I mentioned above, it’s a lot easier to handle emergencies, pay for things online, and make reservations with a credit card.
I think, for most people, the best approach is to keep two credit cards (ideally of different types, such as one Visa and one Mastercard) with lower limits. This way you’ll be able to use cards in most locations, you’ll have the option of using the cards in emergencies, and it will make some transactions easier. Meanwhile having a lower limit, perhaps of just $2,000 on each card, will prevent you from getting too deep into debt.
I’d also suggest that, once you’ve become accustomed to sticking to your budget and handling credit cards with lower limits, the excess spending you engaged in when you were younger will probably no longer be a problem. The habit of budgeting and staying within your spending limit will replace your youthful habit of overspending and you will likely find you no longer have the urge to use up your available credit. Assuming this turns out to be true for you, you can then consider raising your credit limit again to give you a bigger buffer against future emergencies.
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