To Close or Not to Close
Take Charge America Describes 7 Factors You Need to Consider Before Closing a Credit Card
Did you know that closing a credit card can actually damage your credit score?
Americans have racked up more than $800 billion in credit card debt, so it may seem that eliminating the temptation to charge purchases would be a good thing. Mike Sullivan, director of education for Take Charge America , a national non-profit credit counseling agency, says think again.
“It takes credit to earn credit,” he said. “If your goal is to increase your credit score, canceling your credit cards may actually work against you in the short-term.”
The majority of Americans carry between five and 10 credit cards, but industry analysts say many consumers have become addicted to plastic, possessing dozens of credit cards, including cards for individual stores.
“It’s a fine line to walk,” said Sullivan. “Carrying too many cards can also lower your credit score because it increases the chances that you will rack up larger amounts of debt. There is no magic number when it comes to the number of credit cards you should have. It depends on how much money you spend and how much you can afford to pay off.”
However, Sullivan adds that it is important to keep track of your debt ratio. He suggests that ideally, you want to keep your balance on each card to no more than 30 percent of your credit limit.
So, what do you need to consider before closing a credit card? Sullivan has seven suggestions:
Beware of the Debt Utilization Ratio – Closing out cards will decrease the amount of available credit you have and increase your debt utilization ratio. For example, if you have $50,000 in available credit and owe $10,000, then you owe 20 percent of your available credit. If you close one account with a $30,000 credit limit, you will then owe the same $10,000 but it will be 50 percent of your available credit. This can lower your credit score.
Time is on Your Side – A portion of your credit score is based on the length of time that you have had specific credit lines open. That means the longer you have a credit card, the more credit history you have. For instance, if you have two cards – one which has been open for five years and another for 10 years – closing the card that has been opened for 10 years reduces your credit history to five years. That can lower your score, regardless of your total balances. A longer credit history shows that you can manage credit responsibly.
Risky Behavior – Five billion credit card solicitations are sent to Americans every year, many wooing consumers with low- or no-interest rates. If you try to control your debt by opening multiple low-interest cards, transferring your balances and closing cards along the way, you could be sending the wrong signal to potential lenders. Not only can this lower your credit score, many lenders consider it to be a risky credit move. It’s best to pay off your debt, rather than transfer it from card to card.
Fee Overload – Many credit cards carry yearly or monthly fees. Closing those accounts can save you money and prevent you from accumulating more debt. It’s important to read the fine print when applying for credit cards. Fees that seem small accrue over time and can ultimately prove to be very costly, especially when interest is involved.
Tempting Fate – We all have our limits. Sometimes, just knowing that we have available credit is a temptation to spend. If you can’t stop spending, close the card once the balance is paid off, regardless of how it might impact your credit score.
House on the Horizon? – House hunters need to take a close look at the number of credit cards they possess. Mortgage lenders look at available credit as a possible risk. If you have multiple cards, lenders need to consider whether you will charge up those cards and be unable to make your mortgage payment.
Sullivan suggests talking with a credit counselor before making any rash moves.
“There are right and wrong ways to close credit card accounts,” he stressed. “Everyone has a different financial situation, so what’s right for you, may not be right for your friend, neighbor or co-worker. If you’re questioning your credit, talk to an expert.”
For more information on finding a credit counselor, call 1-800-823-7396 or visit www.takechargeamerica.org.