A credit counselor who is trying to help you get out of debt might tell you to close your credit card accounts. If you absolutely can’t prevent yourself from running up your balances, then perhaps you should. But if you want to keep your FICO® scores high, that’s the wrong advice. Instead, you should keep the accounts open and keep the balances low.
The more credit you have available that you aren’t using, the higher your credit scores will be.
You’d think that the opposite would be true – that creditors would look at all the credit you have available and think you’re a poor risk because you could suddenly decide to use all of it. But that’s not the way they look at it.
And the way they look at it is important to your credit scores. To keep your scores high, FICO® wants to see a “credit utilization ratio” that’s low. That means you need to be using only a small percentage of the credit available to you. The “magic” utilization ratio seems to be 30%.
When you close even one account, your credit utilization ratio will go up, even if you don’t make any new purchases.
If you have several cards, they probably have a variety of credit limits. But to keep the explanation simple, lets say you have 3 credit cards, each with a $2,500 limit. You’re carrying a balance of approximately $1,000 on each of two cards, and have a zero balance on the third.
3 cards X $2,500 = $7,500 credit available. Your debt, 2 balances of $1,000 each, is only $2,000.
$2,000 is only 26.6% of your available credit – so you’re comfortably below the 30% limit and your credit card use is beneficial to your credit scores.
But if you cancel one card, now you only have $5,000 in available credit, and your $2,000 debt equals 40% of your available credit.
Now, even though you haven’t spent another dime, your credit utilization ratio is well above the “magic 30%” limit and your credit scores are automatically lower.
This is the reason why so many responsible, bill-paying consumers saw their credit scores fall a couple of years ago when credit card issuers began raising interest rates and lowering credit limits.
Banks are still trying to lower their costs, along with their risks. And, since the bookkeeping involved with carrying an account does cost the banks something each month, unused accounts can be subject to an annual fee or closed for non-use.
To avoid losing your available credit in this manner, be sure to use each of your cards at least once every few months. Charge some purchase you would make anyway, then pay the balance when the statement arrives. You’ll keep your accounts open without paying interest charges.
It really is important that you keep these accounts open, because 30% of your credit score is based on that credit utilization ratio. The only category that holds more weight is how you pay your bills, which contributes 35% to your overall score.
Author: Mike Clover
CreditScoreQuick.com
