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When closing a card affects your credit score

 
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April 1, 2014
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QHi Erica,

I heard your name on the Rob Black Show a while back, and I recall that you said closing a card can lower your credit score. Is this true? If so, what is the best way to handle this? I am considering closing a card — which would also put an end to its yearly fee. Thanks and looking forward to hearing back from you. –Ron

ADear Ron,

I'm so glad you wrote to me because I get to clear up one of my all-time, least favorite credit scoring myths. This one irks me because it's correct only under certain circumstances, yet it's cited as gospel for everyone, at all times.  And then the facts get muddled, causing mass confusion!

Here's when and why canceling an unnecessary or unwanted account can be perfectly fine — and when it can have a negative impact on your credit.

As you're likely aware, credit scores, such as the ever popular FICO, take the data from a consumer's credit file and input it into a mathematical model. Some information is far more important than other information. For instance, the length of time you've been using credit, the types you have and pursuit of new accounts are the minor scoring categories.Ask Erica

Payment history weighs the most, as it counts for 35 percent of your score. Credit utilization — the amount of debt you hold in relation to the amount you're contractually able to borrow — is a close second, counting for 30 percent.

When monitoring credit utilization, pay attention to the balance-to-limit ratio. For scoring purposes, you should keep debt under 30 percent of what you're contractually able to borrow, lest lenders see you as a financial risk. If it appears that you're relying on credit to get by, your credit scores will suffer.

How could closing an account matter? Here's an example: You have two credit cards, with a total charging limit of $10,000, and you owe $2,500. That puts your debt at 25 percent of the ratio, so the utilization portion of your credit score is in the acceptable range. But if you cancel one of the cards and reduce your charging limit to $5,000, you now owe half of what you may borrow. Your ratio would be 50/50 — and your score would sink.

Now, what happens if you had those same two cards but owed nothing? You would have a 0/100 ratio, which is perfect. Closing either of the accounts would not affect this ratio. Therefore, you'd be safe, at least scoring wise, to bid the credit card and its fee farewell.

If paring your cards down will impact the scores that you're hoping to preserve, yet you really want to get rid of this one, you have options. Ask one of your creditors to increase their limit, thus expanding your utilization ratio. Then, close the undesirable account with minimal impact. Or, pay down the liabilities that are appearing on your credit report, then close the card when the balance is lower. Finally, ask the credit card company to consider waiving the annual fee. Many issuers will do what it takes to keep great customers.

Got a question for Erica? Send her an email.


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