By Amy Miller, AFC®
Recently, we’ve talked about paying down debt after holiday spending. Many individuals wonder if they should or should not close their cards once they are at a zero balance and how it will affect their credit rating either way. The answer really depends on a few factors and your individual situation. Here are a few things to consider before making the decision to close or not to close…….
Think track record. This is the amount of time you have been using credit.
The overall average age of your accounts makes up around 15% of your credit rating. Shortening this by closing an old card will reduce the average age of your accounts, which can reflect negatively on your score.
Let’s say you’ve had a card for 10 years and one for 2 years. Closing the oldest card will mean your only open line of credit is just 2 years old (instead of 10). Having longevity and good payment history suggest responsibility and trustworthiness to lenders, which will normally lead them to be more willing to lend to you or extend additional credit lines. From a lender’s perspective, a good long history of on-time payments is an indicator of the probability that future payments will be made in full and on time.
Credit Utilization Rates, sometimes also called Credit Utilization Ratios, are based solely on the amount of revolving credit you are currently using versus how much you have available. For example, let’s say you have $1000.00 of available credit with a balance of $400.00. Your utilization ratio would be 40%.
This ratio makes up 30% of your overall credit rating, depending on the scoring model being used. It is recommended that you stay under that number (30%) so your score and future credit availability is not negatively impacted. Typically, a low utilization ratio shows that you are responsible with your money and are less of a risk. A high ratio can do the opposite and indicate that you may not be very good at managing your finances and pose a higher risk of possible missed payments or non-payment/default.
It’s important to note that this ratio only includes credit cards and lines of credit, also known as revolving credit. Mortgages and auto loans are considered installment loans and are not included in this ratio and are calculated differently.
When should I close a card?
There are times that it may make sense to close the card. An example would be if your card charges a high annual fee or fees for a zero balance. There is no need to pay additional fees on something when you are not utilizing the service.
Some individuals just feel better knowing they are out of debt and that the ability to get back into debt is less likely since they do not have that credit line available any longer. And that is fine, especially if you are ok knowing that your credit report may take a hit for a while. However, closing a card does not get you off the hook for the balance. You are still responsible for paying and will continue to accrue interest and any other fees associated with the card. You just won’t be able to make new purchases.
To close or not to close……???
Generally, it is best to keep them open so that you can take advantage of having a longer credit history and the amount of available credit that comes with it. Since your FICO is partially scored based on those two factors, having long-standing accounts (account age), and only using a small portion of that available credit (utilization ratio) is looked at more favorably and can boost your score.
Any card you use responsibly can have a positive effect on your credit rating so keeping revolving credit lines in good standing and with a low balance can be beneficial for maintaining a good credit standing.
I would suggest reviewing all your accounts before deciding. Take note of your spending habits and any fees you may incur on your cards.
To close or not to close is really a personal financial decision that you will need to make based upon your individual circumstances.