The Surprising Downside of Cutting Up Your Credit Cards

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Cutting up your credit cards
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It's a time-honored tradition for shopaholics: When you realize your spending has spiraled out of control, you take out your scissors and cut up the credit cards that have been getting you in trouble.

If you're getting out the scissors to destroy your plastic, presumably you're also picking up the phone to cancel the account itself. But is that such a good idea?

If the goal is to rein in your spending, there are good reasons to kill some accounts altogether. The prevalence of e-commerce has made it easy to buy nearly anything without a physical card, so if you've got your credit card info stored in your Amazon account, just cutting up the card won't do much. And leaving the account open means that you could, in a moment of weakness, ask your bank to send a new card.

In that case, simply cutting up your cards is a meaningless gesture unless you're also closing the account. But there's a good counterargument: Closing accounts could hurt your credit score.

"Generally the advice is that you not close accounts, especially if you're planning to apply for credit in the near future," says Rod Griffin, director of public education for Experian. "The reason is utilization, which is the second-most important factor in credit scoring."

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Utilization is a simple calculation: It's the ratio of your total credit card balances to your total credit limit. The higher the utilization -- the more of your total available credit you're using -- the worse the impact on your credit score.

For example, say you have two credit cards, each with a $10,000 limit, and a total of $8,000 in debt between the two cards. Your utilization ratio is 8,000/20,000, or 40 percent. If you do a balance transfer to put all the debt on one of the cards and cancel the other account, you shrink the denominator of that fraction to 10,000. Now your utilization ratio is 8,000/10,000, or 80 percent. You owe exactly the same amount as you did before, but ratings agencies see you as riskier, and ding you accordingly.

So if by closing some accounts, you're simply shifting most of your spending and debt onto other cards, you're hurting your credit score to little benefit. On the other hand, if you're also reducing your debt and credit card spending as you close your accounts, the impact on your score will be minimal.

Another thing to consider before closing your account is the age of the account. While not as important as utilization, the length of your credit history also factors into your score, so it's best to shut down "younger" accounts rather than the credit card you've had since college. (With that said, closing an old account won't wipe out the good credit you've built up from years of paying bills on time.)

In any case, Griffin says that you shouldn't let credit-score concerns totally dictate your financial decision-making.

"Even though your credit score may be hurt a little bit, you still may want to close accounts based on your overall financial situation," he says. "The first thing you need to do is eliminate the temptation to accumulate more debt."

If there are ways to completely eliminate that temptation -- for instance, by removing stored payment information from your e-commerce accounts -- then it may be worth it to kill the plastic but leave the account open. But if you think the bad habits that got you into debt in the first place may resurface, then don't leave it to chance: Call up the bank and do what needs to be done.

Matt Brownell is the consumer and retail reporter for DailyFinance. You can reach him at Matt.Brownell@teamaol.com, and follow him on Twitter at @Brownellorama.

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Why Your Bank Thinks Someone Stole Your Credit Card
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The Surprising Downside of Cutting Up Your Credit Cards

One reason why Marquis' gas purchases might have triggered a fraud lockdown? Filling their tank is a common first move for credit card thieves.

"Some of the things they look at are small-dollar transactions at gas stations, followed by an attempt to make a larger purchase," explains Adam Levin of Identity Theft 911.

The idea is that thieves want to confirm that the card actually works before going on a buying spree, so they'll make a small purchase that wouldn't catch the attention of the cardholder. Popular methods include buying gas or making a small donation to charity, so banks have started scrutinizing those transactions.

Of course, it's not a simple matter of buying gas or giving to charity -- if those tasks triggered alerts constantly, no one would do either with a credit card. But Levin points to another possible explanation: Purchases made in a high-crime area are going to be held to a higher standard by the bank.

"It's almost a form of redlining," he says. "If there are certain [neighborhoods] where they've experienced an enormous amount of fraud, then anytime they see a transaction in the neighborhood, it sends an alert."

(Indeed, Erin tells me that one of the gas purchases that triggered an alert took place in a rough part of Detroit, which she visited specifically for the cheap gas.)

People who steal credit cards and credit card numbers usually aren't doing it so they can outfit their home with electronics and appliances. They don't want the actual products they're fraudulently buying; they're just in it to make money. So banks are always on the lookout for purchases of items that can easily be re-sold.

"Anytime a product can be turned around quickly for cash value, those are going to be the items that you would probably assume that, if you were a thief, you would want to get to first," says Karisse Hendrick of the Merchant Risk Council, which helps online merchants cut down on fraud. Levin says electronics are common choices for fraudsters, as are precious metals and jewelry.

Many thieves don't want to go through the rigmarole of buying laptops and jewelry, then selling them online or at pawnshops. They'd much prefer to just turn your stolen card directly into cold, hard cash.

There are a few ways that they can do that, and all of them will raise red flags at your bank or credit union. Using a credit card to buy a pricey gift card or load a bunch of money on a prepaid debit card is a fast way to attract the suspicions of your credit card issuer. Levin adds that some identity thieves also use stolen or cloned credit cards to buy chips at a casino, which they can then cash out (or, if they're feeling lucky, gamble away).
 

When assessing whether a purchase might be fraudulent, banks aren't just looking at what you bought and where you bought it. They're also asking if it's something you usually buy.

"The issuers know the buying patterns of a cardholder," says Hendrick. "They know the typical dollar amount of transaction and the type of purchase they put on a credit card."

Your bank sees a fairly high percentage of your purchases, so it knows if one is out of character for you. A thrifty individual who suddenly drops $500 on designer clothes should expect to get a call -- or have to make one when the bank flags the transaction. If you rarely travel and your card is suddenly used to purchase a flight to Europe, that's going to raise some red flags.

Speaking of Europe, the other big factor in banks' risk equations is whether you're making a purchase in a new area. I bought a computer just days after moving from Boston to New York, and had to confirm to the bank that I was indeed trying to make the purchase. Levin likewise says that making purchases in two different cities over a short period of time raises suspicions.

"I go from New York to California a lot, and invariably someone will call me [from the bank], " he says. Since one person can't go shopping in New York and California at the same time, any time a bank sees multiple purchases in multiple locations in a short period, it's going to be suspicious.

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