What is the downside of applying for a credit card with a great sign up bonus? Not much. Opening a single new account will improve your credit score in most cases. This is one of several popular misunderstandings about how credit cards work.
1. I Pay My Balance in Full, So I Don't Have Any Debt
The smartest way to use a credit card has always been to pay your balance in full every month to avoid paying interest. From a practical standpoint, the cardholder isn't incurring any debt, but that is not how the credit agencies will report it. Each bank will report your current balance as debt, even before you have received your statement. If your balance is reported the day after you have paid your statement in full, the bank will still report as debt all of the charges made since your last statement period ended. So long as this amount reported isn't an unusually large percentage of your available credit, your credit score should not be affected. Otherwise, cardholders who are applying for a new mortgage may wish to pay their balances down before their due date.
2. Applying for a New Credit Card Will Hurt Your Credit Score
When you apply for and receive a new credit card, two things happen that affect your credit score. First, there is a request made for your credit history called a "pull." One pull now and then has a negligible effect on your credit, but too many pulls in a short period of time give the impression that you are facing financial difficulty. Additionally, being granted additional credit will lower your credit utilization ratio, so long as you do not incur additional debt. Since a lower ratio will help your credit score, many cardholders report that their credit score increases slightly when they receive a new card, but don't add to their debt.
3. Canceling Your Credit Cards Will Help Your Credit
Americans get in trouble with credit card debt all too easily. In response, many of them will cancel their cards with the hope of rehabilitating their credit history. This works, but only as a last resort to keep you from incurring more debt. Unfortunately, the simple act of closing your account will hurt your credit score for the same reasons that opening a new account can help. Reducing your available credit without reducing your debt increases your credit utilization ratio, which hurts your score. For some, the solution may be to keep their accounts open and simply cut their cards in half so they can't be used. Of course, a replacement card is just a phone call away.
4. It's Against the Law for a Merchant to Add a Credit Card Surcharge
Retailers are not supposed to tack on a fee for you to use your credit card, but the law has little to do with it in most states. In the United States, merchants enter into agreements with credit card processors that prohibit such surcharges (although these contracts do not bind some foreign merchants). Nevertheless, you have probably found that some merchants insist on charging such fees despite their agreements. Retailers have lobbied Congress to pass laws prohibiting such agreements, but for now, merchants must still sign them to accept credit cards. When faced with these surcharges, your only recourse is to notify the credit card networks that one of their merchants is violating its agreement with them.
The Bottom Line
Credit cards are used widely, but there is a lot of misinformation going around about them. By understanding the facts, you can make the best decisions about your use of these powerful financial instruments.