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.
About the Guest Blogger:
Linda Bustos is an editor for CreditorWeb, where you can learn about credit cards, identity theft, understanding credit reports and more. She is also an active member of the Destroy Debt Forum.
Thanks for the reminder on keeping my credit card accounts open. I do have a couple of credit cards. My main one is linked to a points system & can be redeemed for petrol vouchers etc.
I mainly use my credit card to keep a tab on my spending. Sometimes it can be a rude awakening to see that bill when it comes in. I do pay it off every month in full and it’s been many years since I paid interest.
This information is so important for readers to understand. I believe these money life skills should be taught in our schools to better equip our kids on how to manage & grow their finances.
The debt:credit ratio is one reason I hadn’t closed my older credit cards as I’d heard this before.
Will definitely be checking out your site for more info.
One thing I find so frustrating is that I have the financial info and try to pass it onto my teenager but of course has been falling on deaf ears…. I think it’s called ‘selective hearing’. At least some of his mates listen to me & I can make a difference to their financial future.
I agree that schools should provide more education on personal finance but I also believe a lot of that responsibility should be on the parents.
The problem is that there are many parents that don’t understand personal finance themselves and therefore cannot exactly teach their children about what to do and not do. Thus the cycle continues to repeat unless the child takes the initiative to learn about their own finances.
Keep talking to your teenager and his friends, as even though it may seem like it is falling on deaf ears you might be surprised at how much is actually getting through to him. When he is faced with a decision, he may think: “Oh yeah, I remember my parents telling me about that.”
That is great that you haven’t paid interest in years, keep up the good work!
It’s definitely true that a lot of parents don’t understand personal finance & don’t take the time to learn.
My grandmother & mother were very resourceful & made that $ stretch but I’ve had to teach myself about financial independence & enjoyed the learning curve & reaped the rewards.
I’ve learnt about shares, managed investments & more. I will keep talking to my son & his friends. One day my son will be thankful when I sign over his managed investments that I have been growing for him over the years…until then I will be keeping them safe.
As long as you are not tempted to use it, keeping a card to help your debt-to-credit ratio can be a very good idea. However, at the same time, you don’t want to have too much credit available compared to your income or it can make it harder for you to get new credit (even though your credit score looks great) so there is a trade-off and a fine line.
I definitely agree that having department store cards is almost always a bad idea!
Nick, that is a great point about the temptation. While something may make sense by the numbers, you really need to evaluate your own habits and personality when it comes to your finances.
If someone is tempted by available credit, they may be better off reducing the credit that is available to them even though they may take a hit on their debt/credit ratio. A good portion of financial decisions is dependent on the person involved.