Ditch bad credit card

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Dear Debt Adviser: In an effort to improve my credit, I accepted a very bad credit card offer. My FICO is around 500. The card has a credit limit of $300 with a $6.50 monthly fee and $150 yearly fee and rate of 25 percent, so even if I pay the card off each year $150 is added on. I keep reading that if I cancel cards it will impact my score negatively. This card is horrible. My question is: Should I cancel the card immediately or wait until I pay it off and cancel it? - Mary

Dear Mary: Wow. Many times people have a harder time seeing the correct course of financial action to take than they do in other areas of their lives. So, let me try to relate this to something I think many of my readers may have encountered in their non-financial lives. If this card was a person you were dating who was costing you money and going nowhere in the long-term-relationship department, how long would you keep dating? The same applies here.

What you are experiencing is what the market calls a sub-prime credit card - huge rates and fees with very little credit. I'll bet the $150 annual fee was charged directly to your card, effectively bringing your $300 credit limit down to $150! These cards are designed more to make money for the issuer than to help you build a credit score.

A better option for you may be a no- or low-fee secured card. With these cards you must have money in savings that "secures" the credit limit on the card. Otherwise, you use the card just as you would an unsecured credit card. Make charges and pay them off on time every time to re-establish a good credit history. Many card issuers will convert the account to an unsecured card with a higher credit limit once you have proved a consistent payment record over time. Bankrate.com allows you to compare secured cards and terms at www.bankrate.com/secured.

As to whether you should cancel the card with the horrible terms - yes, go ahead and cancel it. You might want to apply for the secured card first, so you have a credit line open on your credit history.

Now on to improving your credit score - you didn't specifically ask, but as an old financial counselor, I can sometimes hear the real question behind the one that gets asked. Several things will help improve your credit score, but the one that helps the most is time!

While you're waiting, follow these steps to a better credit score:

Pay down debt. The closer you are to the limits on credit card accounts, the more it will lower your score.

Loan yourself money. Open a savings account and take out a personal loan with the savings as collateral. As with a secured credit card, the loan is low-risk for the lender.

Keep older accounts open. You need to show stability on your credit history. Potential lenders and the scoring models view that as accounts that have been established for an extended period of time - more than three years.

Check your credit. By law, you're allowed one free copy of your credit report each year from each of the three major credit bureaus. Do it. Correct any inaccurate information and make sure all your good work is being reported by your creditors.

E-mail Steve Bucci at debtadvis er@bankrate.com.