I’m guessing by now you have some credit cards or a credit card that you’ve thought about closing. You may have even heard some conflicting information about whether or not you should close credit cards. Here is some advice on this issue, taking into account the effect your actions may have on your credit score.
First, a little primer on what affects your credit score.
The most important factor is your payment history. This counts for 35% of your score. So pay your bills on time, even if you are just paying the minimum payment on your credit cards.
How much in total you owe versus your total credit limit (credit utilization) counts for 30% of your credit score. An ideal credit utilization rate would be less than 10%, although less than 20% is still pretty good. Once your credit utilization rate goes over 40%, your credit score will be very significantly impacted.
The amount of time you’ve had credit counts for 15% of your credit score. This is why it’s typically best to keep your oldest credit card account open, even if it isn’t the main one you are using now.
Applying for new credit counts for 10% of your credit score. While applying for a new card or two won’t hurt, regularly applying for new credit cards or other loans will cost you. Also your average credit history (the longer, the better) is factored in here and every time you open a new account your average decreases.
10% of your score is based on the types of credit you have. The more diversity you have the better. Types include revolving (credit cards), installment (car loans), and mortgages.
Now on to closing accounts …
If you have a card with an annual fee that you aren’t using, this would be a prime candidate for closing. Before you close it you can ask your issuer to waive your annual fee or downgrade your card to a no-fee version. If you have a card or other cards from the same issuer (CitiBank, Chase, etc.) you can ask if they will add the credit limit from the card you are closing to one of your other cards, especially if one of those is the main one you are using. If your issuer will do any of the above, your credit utilization will not suffer with the closing. Your average length of time you’ve had credit and the total length of time you’ve had credit may be affected, but this is less significant than your credit utilization.
Also, if you have a card with unfavorable terms, it could be a candidate for closing. Make sure you are affected by the unfavorable term(s). Sometimes a card has some unfavorable terms that in your particular situation isn’t a problem, so there is no need to close the account for that reason.
As I mentioned above, it is best not to close your oldest credit card account since it has your longest credit history. If this card is no longer the one you carry with you and use often for purchases, set up an automatic billing (like Netflix, for example) so the account shows some activity and the issuer won’t be tempted to close it.
You should check with your financial advisor before you make any financial moves even those you see in this blog. They can help you determine an individual path that is best for you.