Many consumers with older or inactive credit accounts sometimes close those accounts. If this is you, think twice.
While closing older, unused credit accounts may help guard against identity theft or keep you from paying annual fees, it can also cause your credit score to decrease.
By closing an old or unused card you are wiping away some of your available credit which can increase the overall amount of credit you are using.
The way FICO looks at the amount of credit you are using is called credit utilization ratio.
Credit utilization makes up 30% of credit scoring. The ratio measures your total used credit in relation to your total available credit. The higher the ratio, the more negative impact on your FICO scores.
For example, if you have a total of $10,000 in credit available on two credit cards, and a balance of $5,000 on one, your credit utilization rate is 50% — you're using half of the total credit you have available.
The length of your credit history accounts for 15% of your credit score. The credit scoring formula rewards good credit habits that display a responsible use of credit over a period of time.
5 Reasons to never close credit card accounts
1. Length of credit history.
Closing older accounts will cause your credit history to appear shorter and once the credit scoring model plugs in the age of your oldest account along with the average age of all your accounts, your credit score will take a dive if you no longer have older accounts to mix in the credit score calculation.
Closing out an old credit card shortens your average credit age, which is 15% of your credit score. Lenders tend to view borrowers with short credit histories as riskier than borrowers with longer histories.
2. Total available credit.
The credit scoring formula calculates the difference between the balance of your credit accounts and your total credit account limits. Your credit scores will be higher if the difference between the account balances and credit limits is large. Using less of your available credit helps credit scores.
Should you close older accounts, the difference instantly becomes smaller and this will ding your credit score because your total available credit has been reduced. As the gap narrows between the utilization of credit and the available credit limit, your credit score will decrease.
3. Damage cannot be undone by closing an account.
Some consumers mistakenly believe closing a credit account can get rid of negative information on that account. You may even believe closing accounts will improve your credit score. This is not true. Negative account information can be reported for up to 7-10 years, depending on the type of information being reported. Successfully disputing negative credit account information and getting deletions will get rid of negative credit information but closing an account will not.
People close credit cards for a variety of reasons. Sometimes, you may have gotten so behind on your payments you feel as if you can never catch up—closing the account seems to be the best option. But it's important to note that closing a credit card won't make late payments go away.
The only exception to closing an old account to get rid of negative information is that you are an authorized user of that account. For example, if an account gets a negative notation such as a late payment and you are an authorized user, this will reflect on your credit reports as well as the account holder's credit reports. But, if you are removed as an authorized user, the negative will no longer reflect on your credit reports. Authorized users are not financially for credit accounts.
4. Limited to one card with available credit
If the card you are considering closing is your only credit card with available credit is likely helping your credit score by lowering your overall credit utilization. Closing this card will leave you with more credit cards that have balances and higher credit utilization.
5. An older credit card may have the best terms
If you have a credit card with a low-interest rate, no annual fee, and perks like rewards points, cashback benefits, or travel insurance, keep it. Compare your current credit cards to a few others on the market right now. If you have a credit card with better terms, it's better to leave it open.
Retain old credit accounts, even if you have to pay an annual fee
If your credit card company is charging an annual fee that you don’t want to pay, ask them to waive it. That way you can keep the older account to help your credit score without paying an extra fee.
Retain old credit accounts, even if you have to pay an annual fee. A good rule of thumb is to use your only card once in a while as well. If you tend to keep low balances, charge something on your card and pay it off. This demonstrates your responsible use of credit.
Closing a credit card with a balance. Having a balance on a closed credit card can look like you've charged the account up to the limit. Here is why: When you close a credit card with a balance, your total available credit and credit limit are reported as $0. Because you still have a balance on that credit card with no credit limit, it looks like you’ve maxed out the account. Since credit utilization is 30% of your credit score, a maxed-out account, or one that appears to be maxed out, will have a negative impact on your credit score.
If your goal is to raise your credit score, never close any of your accounts because you may end up hurting your credit score. In fact, should you have an older credit account consider charging small items on a regular basis and pay the balance off each month. Demonstrating active, current, and responsible use of credit will help raise your credit score. Never using an available credit card account does not demonstrate how well you handle credit and manage debt.