By Adam Funk
Learn more about Adam on NerdWallet’s Ask an Advisor
Debt: Most of us will use it sooner or later, so let’s use it to our advantage.
We can design the perfect credit card limit portfolio that provides access to credit when needed while limiting fraud risk and building a great credit score.
Your goal is to maintain three open lines of credit, or credit cards, with zero balances for the next 20 years. You want to take out installment loans (i.e., student, auto and mortgage) only as necessary.
Credit card No. 1 has up to a $500 credit limit. This is the starter card you get when you’re 18 years old. Twenty years from now, you might still have this card because it serves many purposes. You can keep this card in your wallet as an emergency backup such as when other cards are declined. You take this card when traveling to places where you could lose it, like going on a boat or crazy drunken night on the town.
Use this card when paying a person or business you don’t trust so you limit the possibility of fraud. The small amounts are easily disputable and won’t disrupt your checking accounts or freeze your regular credit card. Because the card has a small limit, having rewards or a low APR interest rate is less important.
Credit card No. 2 has a credit limit of four times your monthly budget for discretionary spending. If your budget is $1,000, then request a $4,000 credit limit. Credit scores penalize you when you max out cards, so setting a limit of 25% utilization builds a good credit history while allowing you a little grace room should you exceed your personal limit. This card is your everyday card.
Like an old-fashioned “charge card,” you pay it off every month. You stay on budget as long as you don’t exceed your $1,000 limit and therefore you won’t have to worry about money daily. Because you pay this card off every month, you don’t pay interest charges, so the APR interest rate is less important. The card can have a rewards program because you use the card frequently, but be aware that rewards programs encourage you to spend more than you plan. If fraud should occur with this card, you’ll have two other cards to use while you dispute wrongful charges.
Credit card No. 3 has a high credit limit. It takes your portfolio limit up to three months of your gross income. For example, this card’s limit would be $10,000 for someone making about $58,000 per year. Why three months? Because you should have three to six months in liquidity for hiccups in life, and credit cards are liquidity when you need it. Keep this card at home. It is for emergencies or for large, planned purchases. You keep this balance at zero. When you use it for a big purchase, pay it off with your savings account or create a plan to bring it back to zero as soon as possible.
People get into credit card debt because they charge things with no plan to pay the balance in a set time and instead only pay the minimum monthly payment. This card should have as low an interest rate as possible, because if you do use it in an emergency, you don’t want to compound the problem with high interest rates that make it difficult to pay back. This card shouldn’t be a rewards card because you don’t want incentive to use it unnecessarily.
Create your own limits.