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Money July 2012

Dollar Sense

Should You Close Unused Credit Cards?

By Teresa Ambord

If you close accounts with zero balances, you may hear a sound like distant thunder. That would be the sound of your credit score crashing.

Credit is fickle. As people seek to get out of debt and raise their credit scores, they sometimes take actions that seem to make sense, like closing unused credit card accounts. Unfortunately, that will generally work against you. If you close accounts with zero balances, you may hear a sound like distant thunder. That would be the sound of your credit score crashing.

Obviously lowering your debt level is a positive thing. But be sure to do it in a way that maintains your credit score as much as possible. You may not expect to need a loan in the near future, but it’s still important to guard your credit history. These days, credit histories are used more and more, not just by lenders, but as a gauge of your general reliability and character. After all, a person may have no arrest record that would show up in a criminal background check, but have a financial past that shows irresponsible use of money. An employer looking to hire a bookkeeper might find that interesting, and a potential landlord may use that knowledge to decide whether or not to rent to you.

Even if your credit score is low for perfectly good reasons, like closing unused accounts, it could cause a door to slam in your face. Before you close credit accounts, take a look at the impact this can have on your credit history. Closing credit cards affects your credit in two ways, length of credit history, and total credit available compared to credit used (commonly called utilization).

 

Credit Longevity

Your credit score is determined by several factors, one of which is, how long you have had credit. Suppose you got your first credit card 30 years ago and made do with just that one for a long time. You may have handled your credit card activity very well, at least in recent years, and that longevity will reflect nicely in your credit score. However, if you decide to close that account because you seldom use it, you are lopping off years of credit history and lowering your credit score. Better to let the card live.

 

Credit Use

Then there is your utilization, or your balance to credit limit ratio. Suppose you have two credit cards, each with a $5,000 limit for a total of $10,000 in credit. One card has a zero balance, and the other card has a $3,000 balance. Your utilization rate is 30% ($3,000/$10,000 = 30%). You decide to close the account that has a zero balance, which lowers your total credit to $5,000. It also raises your utilization rate to 60% ($3,000/$5,000 = 60%). That creates the impression that you have gone on a wild spending spree, using up a great deal more of your available credit. The impact is, your credit score plummets.

With all that said, if you are a person who cannot trust him or herself to keep the cards open and not use them (or use them cautiously), you might be better off to take the hit on your credit score and close the cards. If that’s your decision, employ a strategy that will minimize the effect on your credit score.

 

Here are Some Tips

  • Don’t close any account just before you intend to apply for a loan, like a mortgage or car financing. Also don’t open an account as this will work against your credit score too.
  • Don’t close all your accounts at once. Instead spread out the closures over time to lessen the impact on your credit score. Make a list of the length of time you’ve had each card and the credit limits. Put aside the cards that you’ve had the longest and that have the highest credit limits. That preserves the length of your credit history as well as the total available credit compared to use.
  • After you close one account, go easy on new charges on your remaining cards for a few months. Credit scores are calculated on monthly balances, so keeping your other charges low will minimize the impact. If you decide to keep your cards open and just not use them, your credit card issuer may do one of two things: close your account because of inactivity, or slap you with a fee for inactivity. That’s why you need to open all mail from these accounts, even if you assume it is just a solicitation. The last thing you want is to have a fee that you don’t know about, and end up incurring a delinquency and more charges.
To avoid the problem of inactivity, use your cards now and then but for purchases you would make anyway. Perhaps you could dedicate one card to be your gas purchase card. Then be diligent about paying off the balance at the end of the statement period. Assuming you are only buying items you would buy with cash anyway, this should be easy.

Again, credit is a fickle mistress. Credit scores are like the modern day crystal ball. More and more they are used to judge who you are, though it’s far from a perfect system. Before you do anything rash with your credit accounts, take a step back and consider how the action is likely to reflect in your credit score.

You can learn more about credit scores and how they are determined by logging onto http://www.myfico.com/CreditEducation/WhatsInYourScore.aspx.

 

Teresa Ambord is a former accountant and Enrolled Agent with the IRS. Now she writes full time from her home, mostly for business, and about family when the inspiration strikes.

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