‘Tis The Season to Avoid Retail Store Credit Cards; Here’s Why

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Starting this Friday, many of us will go temporarily insane.  This temporary insanity will likely run from Black Friday until the week after Christmas, and will include camping out in front of stores set to open at 4 am, so you can have the first crack at the new hot gifts for the 2010 holiday season.

And while you’re lining up to spend, spend, spend, the army of cash register attendants will be ready to hit you up for a new store credit card in exchange for a modest discount on your purchases.

What can be wrong with saving 10, 15 or even 20% on your purchases?  Well, a lot can be wrong with using your credit reports and scores like store coupons.  Here’s what can go wrong and why you should avoid opening new store credit cards at all costs.

1. They’re subprime credit cards with a store logo

Retail store credit cards are notorious for having very low credit limits and very high interest rates, regardless of what kind of credit you have.  If I asked you to close your eyes and tell me what kind of credit card has interest rates in the mid to high 20s and credit limits less than $1,000, I imagine most of you would say “a subprime card for someone with terrible credit” — and you’d be right.

But, you’d also have to include retail store cards in that mix.  Look at the next statement you get from any retail store, regardless of which one, and you’ll see what I’m talking about.  If you choose to use a credit card for your purchases you’re better off using an existing card, preferably one that has a very high credit limit especially if you don’t think you’ll be able to pay it in full.

Think about the impact to your credit when you use a retail store card, even for modest purchases.  A $500 shopping spree on a card with a $1,000 limit leaves you 50% utilized on that card, which is not good for your scores.  The same purchases on a general use credit card, like a Visa, MasterCard or Discover, with even a modest credit limit of $5,000 leaves you 10% utilized assuming you use that card for all of your shopping.  That’s much better for your scores.

Additionally, if you do carry a balance from one month to the next, you can kiss your savings good-bye and you’ll quickly find yourself in the hole.  Retailers have significant margin built into their goods to play with, so giving you a “same day shopping” discount is really a painless loss leader just to get one of their cards in your wallet.

So what’s wrong with opening the card just to get the discount and then closing it the minute it shows up on the mail?  Here’s what’s wrong with that…

2. Your credit will likely suffer even if you close the account

Applying for a card at the register is an extremely unsophisticated way of applying for credit, but it is a credit application, a fact that many consumers don’t realize until it’s too late.  Here’s the chronology of events that occurs when you apply at the register: your credit is pulled, an inquiry is posted to your file, a decision about your application is made, and a new account is possibly issued in your name. Within 30 to 45 days, that new account will show up on your credit reports.

None of this sounds problematic, but retail store inquiries are the most damaging type and do not enjoy the same FICO exclusion logic described in this Mint article.  This means that if the inquiry is going to lower your score, then it will do so for a full 12 months, until next holiday season.  Notice I used “score” in the singular. Only one of your three credit reports will be pulled so the inquiry will only show up on of your three credit reports — so, at worst, it will impact only one of your FICO scores.

However, when the new account is opened it will likely be reported to all three of the credit reporting agencies.  The minute it hits your reports, it will impact what’s called your “time in file.”  This is the category of FICO scoring that awards or penalizes you for the age of your credit file.  Adding a new account, or several of them depending on your shopping aggressiveness, will lower the average age of your accounts and can cause your scores to go down.  Notice I used “scores” in the plural.  So what if I don’t plan on shopping for credit in 2011?  Then I don’t need to worry about this, right?  Here’s why you should always be worried…

3. You don’t know what you don’t know

It’s true that inquiries only impact your credit for 12 months and it’s also true that the impact of new accounts will lessen quickly over time.  Stipulated!!

But what happens if your car dies in 2011 and you need to finance another one?  What happens if, through some miracle, you are able to refinance your home loan in 2011?  What happens if you want to consolidate your student loans in 2011?  These are all long-term loans where every basis point of the rate is financially meaningful.  Costing yourself even an 8^th of a point because of your holiday shopping is going to cost you a whole lot more than you saved on your new boots.

And what if your insurance company checks your credit before reissuing your auto or homeowner policies and the lower score leads to a higher premium?

As I said: you might not be planning on financing anything new in 2011 but you don’t know what you don’t know.

John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and the author of the “credit history” definition on Wikipedia.  He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry.  He has served as a credit expert witness in more than 70 cases and has been qualified to testify in both Federal and State court on the topic of consumer credit.