Credit Score Myth: Closing Credit Card Accounts Helps Improve Your Credit Score
Many people wrongly assume that closing down credit card accounts will either prevent them from getting into more debt or even help their credit score, but this is a misconception. It’s important to differentiate the right and wrong reasons for shutting down open accounts.
Good reasons to close a credit card account:
- You are the victim of identity theft
- You are worried a co-signer might rack up debts (for example, an ex spouse or family member)
- Your credit card company is charging you ridiculous fees it won’t waive, like a high annual fee
- Your financial institution is unstable or uses unethical practices
Wrong reasons to close a credit card account:
- You’ve finally paid down a credit card and you figure closing it down will make you appear more responsible on your credit report
- You’ve recently obtained a lower interest credit card and want to close an older, higher interest card
- You’re afraid you have too much available credit
- You can’t control your spending and want to shut down all available credit sources
Why are these poor reasons to close accounts? Credit score is based on a number of factors including the age of your accounts – credit lenders like to see that you have been loyal to your creditors. One of the benefits of owning a credit card earlier in life is to establish good credit history. Closing your older accounts immediately cuts down your credit history.
Another factor is your debt:credit ratio.
Also, older accounts are likely to have higher limits as credit card companies will bump up limits for customers in good standing every six months or so.
It’s much better to have $15,000 available credit and use only $5,000 of it than to make a balance transfer to a new card with a $5,000 limit and close your older, $10,000 limit account. You will jump from a decent 30% debt-to-credit ratio to a dismal 100%. So if you are going to close inactive accounts, choose more recent ones with low credit limits. But you probably don’t even need to close them. You can’t have too much available credit unless you’re too tempted to rack up higher bills. In that case, you can cut up your physical cards while leaving the accounts open.
When leaving old accounts open, it’s a good idea to use the card at least once every six months to make sure your credit lender does not close your account for you due to inactivity which would negatively impact your credit report. You could set up automatic payments for cellphone bills or monthly charitable donations for your older, higher interest cards to keep them active, and connect them to your online banking service, making sure to pay in full each month.
If you do need to close down accounts, it’s best to do so gradually, at a rate of one per month as closing down multiple accounts in a short period of time can trigger a temporary drop in credit score.
About Retail and Gas Credit Cards
Credit cards issued by retail stores or gas stations (unless they are Visa or Mastercard with retail or gas rewards) are not as beneficial credit references as regular cards because many use less reliable, smaller financial companies and they also approve almost anyone who applies. Some have even suggested that each retail store credit card you open lowers your credit score by 20 points.
These types of credit cards come with crushing interest rates in exchange for rewards points or discounts. Many department stores try to lure you into signing up with discounts off your initial purchase. Because these are lower value forms of credit, don’t just sign up to get a one-time perk. Only sign on for stores you will shop frequently in and that you will be able to pay off the balances each month.
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