Should you really cut up unused credit cards?
Cutting up credit cards is synonymous with tackling debt, but it might not actually be the best course of action.
According to research from uSwitch.com produced earlier this year, as many as 16 million people have more than two credit cards they no longer use, with 7% of these holding up to six redundant cards.
The price comparison website also found that 10 million people have stopped using their credit card since the start of the recession, while 1.8 million have taken scissors to their plastic to avoid temptation once and for all.
But is cutting up unused credit cards really the best course of action?
The first thing to bear in mind is that cutting up your cards is no good if you fail to close your account at the same time. For a start, unless you are diligent about destroying it, it is possible that fraudsters could get their hands on your cut-up cards and use the information on it to steal money.
An increase in fraud is well recognised as a knock-on effect of recession, and this time round has proved no exception. According to uSwitch, fraudsters enjoyed a spending spree of £54.1 million on lost and stolen credit cards in 2008.
With an estimated 38 million dormant cards in the UK, there is a risk that consumers won’t even be aware that such fraudulent activity is taking place. If cards are registered to an old address, it could take several months or even years for you to realise what is happening.
If fraud was reason enough to close your account rather than just cut up the card, you should also bear in mind that you risk being charged for not using your card.
From 1 October 2009, American Express will introduce a £20 annual fee for customers who don’t use its Platinum cashback credit cards for a year. Lloyds TSB, meanwhile, charges a £35 dormancy fee after six months, and some Santander cards levy £10 a year if the card isn’t used for 12 months.
Peter Harrison, credit cards expert at monysupermarket.com, says it expects to see more providers introduce dormancy fees in the future. “It costs card firms money to issue and maintain cards and they are required to set capital aside to cover your credit limit,” he explains.
“Fortunately, the dormancy charge is easy for consumers to avoid - either by using the card at least once a year, or by cutting up the card and closing their account.”
A third reason for cutting up and cancelling your credit card is the impact credit agreements have on your credit rating.
When you make an application for credit, the provider will check your credit record and review your employment details and other information supplied in your application form before giving you a score – known as your credit rating.
Your credit report includes all your credit agreements within the past six years. There is a risk that numerous credit cards agreements could ring alarm bells with providers, even if these are unused or you have never missed a payment. In addition, the amount of credit a person has at their disposal might also cause concern, as it suggests the potential for you to run up great piles of debt.
Failing to close down old credit cards puts you at risk of being rejected for further credit, such as a mortgage, in the future. Even if you aren’t rejected, a lower score might mean you have to pay a higher interest rate on a credit card or personal loan.
Closing down a credit card account should be an arduous experience.
“Cutting a card up simply stops you using it - instead call up the card company and tell it you want to cancel,” explains Louise Bond, personal finance expert at uSwitch.com.
However, be warned that asking your credit card provider to close your account might not be sufficient. Bond advises you also make the request in writing, just to protect your interests should something go wrong.
In addition, it’s worth checking with your provider a few months down the line that the account has been shut down, as some will leave accounts dormant for a while until payments come through.
There are many good reasons to close down unused credit card accounts, but before you do it’s worth considering whether it might not be better to keep the account active.
Providers are increasingly cherry-picking the people they want to lend to, and may reject your application if you’ve got a less than squeaky-clean credit history. Think about whether you might need to use a credit card in the future, and whether you are likely to be approved for a deal or not.
Bond says: “In times of such financial turbulence, it's hardly surprising that people don't want to let go of what they consider to be a financial lifeline.”
Generally speaking, hoarding several unused credit cards is unnecessary. However, it you only have one then it might be worth holding on to, especially as making payments on plastic can offer you greater consumer protection. Purchases between £100 and £3,000 made on credit cards are covered under the Consumer Credit Act, meaning the provider can be liable should something go wrong with your purchase.
However, remember that the best way to use a credit card is to pay off the balance within the interest-free period. If you don’t, then you will start attracting interest on any outstanding balance.
A report containing detailed information on a person’s credit history, a record of an individual’s (or company’s) past borrowing and repaying, including information about late payments and bankruptcy. It also includes all applications a person has made for financial products and whether they were rejected or accepted. Your credit report can be obtained by prospective lenders to determine your creditworthiness.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
Cashback credit cards
These reward you with a small percentage of cash back on your total spend on the card, either each month or annually. Cashback cards carry high APRs and ONLY work if you pay your balance off in full every month. If you miss payments and have existing credit card debts, leave these well alone.