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Committing to a Credit Card? Don’t Underestimate Annual Fees

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This guest post on credit cards was written by Jason Bushey. Jason is a full-time personal finance blogger and the Editor of Creditnet.com, an online authority on credit cards and credit repair advice.

A lot of people don't realize that when they apply for a credit card, they're making a pretty serious financial commitment.

'Why so serious,' you ask? Because it's generally a bad idea to close a credit card account since it lowers your overall credit line and halts the payments history associated with that card – both of which can have a marginal negative impact on your credit score over time.

I'm in my mid-20's, and I've had my first credit card for nearly seven years; do you know how many girlfriends, apartments and jobs I've ripped through in that amount of time? Had I known that I was making what amounts to a semi-permanent commitment when I applied for that card (which has NO rewards and a steep ongoing APR), odds are I would've shopped around a little (or at all) before signing up for that first card.

That said, there's one thing I'm fortunate my first credit card does not have: an annual fee. In fact, this is the sole reason I've left this old credit card open all these years, and it's really the only thing it has going for it.

No annual fee credit cards are best for a long-term credit card commitment because they're low maintenance and essentially free to carry in your wallet. Once I paid off the balance on that first card, I just sort of set it aside and forgot it existed completely.

Granted, I'm leaving myself open to account closure based on inactivity (ideally I would make at least one purchase a month and pay it back on time), but the balance attached to the card still shows up on my credit report. Having a high credit limit lowers one's credit-utilization-ratio – which is essentially your available credit line (or all of your credit) in relation to the amount of credit you owe – and thus improves your credit score over time.

Long story short: it's best to keep that available credit line high for as long as you can. That's the basic reasoning behind keeping credit card accounts open, and since it's better to keep them open for free rather than pay a fee each year, credit cards that don't require annual fees are recommended in the long run.

Another reason you should hesitate from closing credit card accounts is your credit history. Again, the longer you leave an account open, the more significance it takes on in the eyes of creditors. It's like a relationship; your friends and family obviously take the partner you've been with for a longer term more seriously than a new fling. Showing a strong and positive commitment to a credit account over time goes a long way toward building your score.

OK, so are no annual fee credit cards always better to carry? Well, yes and no...

It used to be that cards that required an annual fee offered more rewards, cash back and points than the competition that didn't require these fees; American Express used to be the go-to example. Over the last several years however, the gap in quality between the two categories of cards has become less and less obvious. Today, there are some excellent cash back options available that require no annual fees for the duration of your cardmembership; so long as you're paying off your bill in full each month, these cards are essentially free to own.

That said, there's one category of cards – airline credit cards – that usually require an annual fee but offer some sweet perks you won't find on freebie cards. Airline miles, boarding privileges and companion tickets with your favorite airline all generally require an ongoing annual fee. However, you might find that the money saved with such a card far outweighs the annual fee you're paying each year, and suddenly that annual fee doesn't look like such a bad deal.

When it comes down to it, it's really up to the quality of the card and how you plan on using it to determine whether or not an annual fee is worth paying. But it's important to remember that credit cards aren't meant to be applied for on impulse (and yes, this includes retail credit cards) – they're actually a pretty serious financial commitment, especially if you value your long-term credit score (which of course you should).

So think twice about bonus miles and intro offers in the mail and consider the long-term benefit of a credit card BEFORE you apply for it, not after. Your credit score – and your wallet – will be better for it in the long run.

Last updated on July 3, 2013.

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Credit, Credit Cards

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7 Responses to “Committing to a Credit Card? Don’t Underestimate Annual Fees”

  1. Steve says:

    Well it depends. There are two reasons you might not want to close a credit card (as I understand it):
    1) If it is your oldest card, then closing it would shorten the length of your credit history.
    2) Your usage ratio, as described in the post.

    The former can be avoided as long as you have at least one card without a fee, that’s at least as old as your fee-laden card. I haven’t found the latter to really be an issue insofar as it’s generally easy to get more credit than you could possibly (responsibly) use. You could probably open another card using your existing credit history, and then close the old fee-laden card.

    But I do agree in the sense that more than once I’ve seen the question “My oldest card has an annual fee, should I close it?” And the answer I always give is, unless you are imminently going to apply for a mortgage, just go ahead and close it. The hit to your credit score, if any, will probably fade in a year or less. Or at least ask for it to be converted to a fee-free card from the same issuer.

  2. Inderpreet Kang says:

    I have TD travel card for collecting travel points. I thought of closing it & open cash back credit card as my wife owns CIBC aero plan card.

    Should I not close the Td card ?

  3. Lazy Man says:

    I don’t know if there’s a hard and fast rule for when you should close a card. Typically, you want to keep as much credit as possible because a calculation that credit scores use is a ratio of the credit you use vs. credit you have available. They also use the average age of credit lines. So if you close this card, you’ll lower the amount of credit you have available and raise the ratio. If it’s an old card, then you may also reduce the average age of credit lines.

    If you pay a fee for the card, perhaps you can get it transferred to a card without a fee. If you don’t pay a fee, there’s really not much reason to close it.

    If it seems like a backwards system to you, then we see eye-to-eye. Seems very weird that closing a credit card would hurt my credit worthiness.

  4. Cassi says:

    Thanks for the information! I currently do not have a credit card, and I plan on keeping that trend for as long as possible, but I know that I should shop around and start looking for one so that I can work on raising my credit. Thanks for the article!

  5. […] Man @ Lazy Man and Money writes Committing to a Credit Card? Don’t Underestimate Annual Fees – OK, so are no annual fee credit cards always better to carry? Well, yes and […]

  6. […] Man @ Lazy Man and Money writes Committing to a Credit Card? Don’t Underestimate Annual Fees – OK, so are no annual fee credit cards always better to carry? Well, yes and […]

  7. Tish says:

    I love the analogy in the beginning regarding mates and apartments. We do spend even less time selecting a card and we shouldn’t, they are harder to get rid of. That said, you can shop for a better card while keeping your existing one open. Keep in mind you do build credit by paying back car loans on time so having a major credit card is not only way to drive your credit score. Also, keep in mind ideally, you want to keep your overal credit ratio below 33% — you don’t want to be over extended. NIce article.

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