Closing credit card accounts hurts credit score
If you even contemplate closing credit card accounts, you may want to stop right there. Closing an established credit card account with $0 balance hurts your credit score and does it in more than one way. I did this many times in the past - cut credit card in a few pieces, then call the bank and asked to close the account. Not anymore, today, I would simply put the credit card away and stop using it. But I want keep that account open in good standing and reported as such to the credit reporting agencies. Why? The image above clearly shows you that closing credit card affects credit score in two ways - from Amounts Owed which contributes 30% in to total FICO algorithm, and from Length of Credit History which contributes 15%. The amounts owed category is basically you debt or credit utilization ratio.
Either closed or open credit card account is treated the same by the FICO algorithm, so closing credit card accounts does not lower the FICO scores in itself but hurts you in the short term, because closing a credit card often affects your credit utilization percentage which definitely lowers your credit scores. Long term, a closed credit card account without negatives and $0 balance will be dropped from the credit reports after 10 years whereas open account stays forever. Once the account is dropped, you lose its credit history and age, and this can hurt scores.
To get a full grasp on how closing a credit card account affects debt utilization ratio and consequently your credit score, understand that FICO scoring algorithm calculates this ratio two ways for every credit report. First, it calculates and considers the individual ratio for each revolving account, including credit cards and home equity lines. The second is cumulative ratio which calculates and considers the extent of utilization across all revolving accounts. Here is an example what would happen with the credit scores of someone who has 4 credit cards and then closes one.
credit card #1
$5,000 limit and $500 balance results in 10% utilization ratio - VERY GOOD
credit card #2
$7,000 limit and $2,100 balance results in 30% utilization ratio - JUST OK
credit card #3
$2,000 limit and $1,500 balance results in 75% utilization ratio - BAD
credit card #4
$2,000 limit and $100 balance results in 5% utilization ratio - EXCELLENT
While the cards #1 and #4 have very good and excellent utilization ratios respectively, #2 and #3 have just OK and bad respectively. Let see now - the cumulative debt ratio between total balance of $4,200 and total credit limits of $16,000 is 26% which is not bad at all but far from ideal. Still it neutralizes somewhat the 75% ratio on the card #3.
But what would happen if you decide to pay off that $100 balance and close the card #4? That the situation which happens with almost every credit card user whose credit IQ needs some improvement. The line of thought is something like this - large credit limit and I barely use it, hmm ... might get lost or stolen, let me just close it. And so he or she does and in the process hurts credit score. Here is why - the cumulative debt ratio now between $4,100 total balance and $14,000 total limit is 29%. While it is only 3% increase in cumulative debt utilization ratio, you would also loose the excellent 5% utilization ration on the #4.
Thus is the conclusion - closing credit card accounts hurts credit score and there is no need whatsoever to close a no-annual-fee credit card with $0 balance. You can cut it and basically forget it. Better yet, you can put away in a secured spot and keep it there. Just in case.
Sun Mar 6, 2011 11:03AM | Copyright: www.bad-credit-advisor.com | More in Credit Repair Tips | Comments (0)
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