Tips on Closing Your Credit Cards: The Real Consequences
When someone is considering paying off debt, they are often under the misconception that closing a credit card will damage their credit score. While this may be true in some circumstances, there are many instances in which it will not cause a score to drop. When helping people decide whether to close a credit card account, there are two important factors to consider.
First, consider whether you still owe a balance on the credit card. If you do, this is probably not the time to close the card. By electing to close a credit card before it is paid off, you effectively lower your available credit limit-to-credit balance ratio (utilization ratio). To have a good credit limit ratio, you need to keep balances at 30% or less of your available credit limit. When you close a credit card with a balance on it, you effectively lower the credit limit to the level of the current balance.
Here is an example:
Open credit card: credit limit is $1,000; current balance owed is $300.
Ratio = 30%
Closed credit card: credit limit is $300; current balance owed is $300
Ratio = 100%
That 100% is very hard on a credit score and will cause it to drop. It is important to note that utilization rates do not look at one card at a time. If someone has multiple cards, the rate will consider the total limits and amounts owed on all cards. If possible, pay off your credit cards in full each month.
Another misconception about closing credit cards is that the card will be removed from the credit report after seven years. The truth is that positive credit history can remain on your credit report forever; even if you close the account. The only items required to come off a report in seven years are negative entries (10 years for some items like bankruptcy and judgments). It is true that items that have not been reported in the last 24 months may not be as heavily weighted in a credit score. However, they will still be included.
Finally, think about how you may be using your credit in the next six-to-12 months. If you are considering purchasing a home or a car, you may do better to wait to make changes to your credit until after you have completed the purchase. It is not a time to be opening a new credit account or incurring additional debt on existing accounts. At that point the focus should be on paying down any credit card debt you may already have.
Bottom line, when considering closing credit card accounts make sure the accounts are paid-in-full first. Also, understand that a positive account in good standing may remain on a credit report indefinitely. That is a good thing.
To learn more about managing credit and credit cards or to learn more about options for getting out of debt, visit www.myfinancialgoals.org.