Dave Ramsey is one of the most popular and influential personal finance writers and radio show hosts of our time as well as the biggest anti-credit card advocate. The man has boiled the personal finance lessons of The Richest Man in Bablyon and other famous personal finance guru’s into seven easy to follow steps. While the steps are fantastic advice and starting points, I vehemently disagree with one essential point: cutting up your credit cards. Yes credit card debt is huge in this country. The average U.S. household has almost $16K dollars in credit card debt! That’s absurd. But the fact that Ramsey wants you to cut up your credit card ignores some pretty central issues about how our credit scores, those little things we need to purchase homes and get apartments.
Before we get too far into debunking the credit card myth here, go and check your credit score. The easier way to do this, in my opinion, is with Credit Karma. Primarily because it is free! Now I’m not paid by them or affiliated with them in any way other than the fact that I use them to track my credit score. What they do is break your score down for you and show you what areas are important and need to be worked on. In building our road map to financial health, this can prove to be invaluable.
Once you’ve filled in your information you’ll notice some sections regarding you credit score: Credit Utilization Rate, Debt to Income ratio, Length of time you’ve had accounts, etc etc. This is where the Ramsey method begins to fall apart. If you cancel your cards your score will go down! That’s right, down. The reason is that if you cancel you’ll be negatively affected in the areas I just mentioned. The length of time you’ve had your accounts will change when you cancel; if you cancel your older credit cards it will get shorter and thus, worse. If you cancel your credit cards you’ll lose the availability of debt, which means your credit utilization rate will skyrocket. These two items alone can knock your score down 100 to 200 points. When trying to buy a home that can mean the difference between being a prime buyer and a sub-prime buyer. AKA the difference between spending more on interest for your home or less.
The other area I disagree with Ramsey on is having a credit card in general. He says we should never use credit cards. I say we should always credit cards, so long as you pay the balance off every month. I learned this from my mother years ago; if you pay off your balance in full every month then you’ll increase you credit score, which means the credit card companies will increase your limit, which improves your credit utilization ratio, which increases your credit score and so on and so on. Even better are the rewards programs out there now. I’m not talking about airline miles because that is always a rip off. I’m talking about cash back rewards cards, specifically the higher (5% or more) rate cards for gas and groceries. If you’re going to be able to pay your credit card off in full every month and you have to buy those groceries or fill up that gas tank anyway then why don’t you use the card and get cash back. Sure, there are limits to how much you can get but let’s look at this with a little bit of math here. Let’s say you have a credit card that gives 5% cash back and you and your family spend $550 a month between gas and groceries. That is $6,600 a year in expenses. 5% cash back on that is an extra $330 dollars, which is less than the capped limit but still a substantial dollar amount. That could be one or two car payments or it could go towards the kids college fund. The point is it is money, that if you maintain good financial discipline with your credit cards, will be handed over to you free from the banks and credit card companies. So why not game the system a little bit, just this time?