“John, I have heard if you close a credit card account it can lower your credit scores? That doesn’t make any sense to me. First off, is that true? Second, if it holds true, how can I prevent reducing my credit rating?”
This is, sadly, extremely true. Closing charge card accounts can result in a lower credit rating.
This fuels the argument of some that recommend that credit ratings reward consumers who owe money, however that’s not actually real.
How Closing a Credit Card Might Hurt Your Credit
First off, there’s no assurance that closing a credit card will decrease you credit scores. It’s a possibility however certainly isn’t a definite.
When you close a charge card account you aren’t able to use the credit line related to that card.
And, due to the fact that you’re no longer able to use that credit limit, credit scoring models no longer think about the restriction in their “balance to credit limit” measurements.
That’s the one and only reason why your rating could go down by closing credit cards.
Here’s How the Math Works…
If you’ve 2 credit cards each with $10,000 credit line then you’ve an aggregate credit line of $20,000.
Let us say you’ve a $5,000 balance on one of those charge card, so your aggregate balance is $5,000.
Your balance to credit limit ratio is determined by dividing the aggregate balance by the aggregate restriction, or $5,000 ÷ $20,000 = 25 %.
FYI: 25 percent is not an awful balance to restrict portion, yet.
If you were to close the unused charge card, for whatever reason, then you wouldn’t be able to consider the credit line from that card, so you ‘d need to take out $10,000 from the aggregate limit amount.
So, the math now looks like this: $5,000 ÷ $10,000 = 50 %. And 50 percent is bad at all.
That’s the one and only reason your score can decrease when you close a credit card. This is called a “spike” in your balance to restrict ratio.
There are some people who believe your score might go down due to the fact that you’re in less financial obligation. That’s simply not real.
Closing a credit card, like in my example above, doesn’t decrease your financial obligation by even one penny.
If you are in $100,000 of debt with an open charge card, you are still in $100,000 of debt with closed charge card.
The even more typical misconception, as it pertains to closing charge card and reducing credit ratings, is that you lose the value of the age of the account when you close it.
That’s not true.
The age of a credit card is identified by a credit scoring model taking a look at the “Date Opened” field on a credit report and determining the age of that account.
That procedure doesn’t change just because the card is closed.
A 10 years of age American Express card is still a 10 year old American Express card whether it’s open or closed.
In truth, closed accounts even continue to age.
So, if you’ve a 10 year old charge card as of today, that credit card will be 11 years of ages one year from now.
Do not think anything you keep reading the internet that recommends you need to close newer accounts instead of older accounts due to the fact that of the age problem.
So, Which Account Should You Close?
If you are going to close a credit card account, then you need to decide to close cards with lower credit line in lieu of those with greater credit limits.
Closing a retailer charge card with a $1,000 credit limit’s going to be much less bothersome for your credit rating than closing a charge card that’s a $25,000 credit limit.
Of course, if by closing a charge card account you go from having a very reduced balance to limit ratio to, once again, having a very low balance to limit ratio, then the effect to your credit scores is likely to be immaterial.
It’s just when, by closing a card, you leave yourself with a much greater balance to restrict ratio that you need to be worried about your scores.
Here’s a little cost-free recommendations … I’d never ever close a credit card before obtaining any type of loan.
Wait till after you close on your loan, and then close any undesirable credit cards.