Dear New Frugal You,
I currently have one credit card through Capital One, and it is my first one. I've had it for almost three years now, and I pay all of my balances off before the end of the month because I only spend what I can so I won't have interest to worry about.

A couple of months ago, I called in to lower my interest rate, mainly because I wanted to see what the company was willing to offer. My rate wasn't lowered and, since then, I've been feeling a bit disappointed.

My bank has been sending me mail about its card, which appears to be much more enticing as it better fits my needs. I've been considering switching over, but I'm afraid that closing my current account may be harmful to my credit. I only want one card at a time and have thought of maybe opening the new card and, perhaps, closing the one I have a month or two later. I'm also concerned I may be penalized for closing my account before our contract ends in March 2011. I've read the articles on here, and it says that there is no penalty, but I know credit cards are tricky. I don't want any damage done to my credit. This is nerve-wracking to me, as I one day want to purchase a home and don't want to have to be concerned in the future about an ill-informed mistake I make now.

I would really appreciate your help with this matter. Thank you! -- Lucy

 

Dear Lucy,
Congratulations on being in an enviable position. You've begun building your credit score on a solid foundation. You've also avoided the trap of borrowing so much money from the credit card company that you couldn't repay it before interest accrued. Plus, you have banks that are encouraging you to do business with them.

Before we get into what to do, let's look at what you're trying to accomplish. The bottom-line goal is to build your credit score so that you can get a favorable interest rate when you apply for a mortgage some day.

Right now, a low interest rate on your credit card isn't important to you. Unlike people who carry a credit card balance each month, a lower rate doesn't do you any good. By not lowering your rate, the credit card company may have failed to show you any love, but even if they had cut the rate, you wouldn't have a single extra dollar in your purse.

Keeping that in mind, let's decide what to do with your current credit card. We've already determined that there's no financial reason to close the account. And, there is no direct penalty for closing a credit card account. Credit card accounts are meant to be revolving credit, which means that the account continues until one of the parties decides to close it.

But canceling your current credit card may hurt your credit score, at least indirectly. It's not because you closed the account, but because you'll be reducing the length of your credit relationships. Fifteen percent of your credit score is based on the length of those relationships. Swapping cards will mean replacing an account with three years of history with an account with no history.

Since there's no financial advantage to closing the current account, you'd be wise to leave it open.

What can you do to continue to build your score? The main thing is to continue to pay your card in full, on-time, each month.

You might also want to rethink your decision to only have one card. The Credit CARD Act of 2009 is causing credit card companies to come up with new ways to make money. That means that for the next couple of years they'll be adjusting things such as annual fees and even canceling some cards. You wouldn't want your only credit card account to be closed just before you apply for a mortgage.

Opening a new credit card account now will temporarily drop your score a few points. But as long as you use it like your current card -- paying it off completely each month on time -- your score will bounce back in a few months. Since you're not borrowing money now, it's the perfect time to add a card.

The second card will increase the amount of unused available credit (affecting 30% of your score). It will also build your credit history. Plus, it will put you in a better position if your current card should be canceled.

You're in a good position to gradually build your score. Aim for a minimum of 760 before you apply for a mortgage. That'll get you the best borrowing terms.

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