Get tips about closing a credit card and whether it can hurt you.
Five Factors that Affect Your Credit Score
According to myfico.com:
- The factor that influences your credit score the most is your payment history. Whether you’ve been naughty or nice to your creditors makes up 35% of your score. So remember to pay all your bills on time.
- The second most important variable is the number of accounts you have and how much you owe on them. That makes up 30% of your score.
- The third most important factor is the length of your credit history. Having long-standing credit accounts is important and can make up as much as 15% of your score.
- The fourth factor is the number of recently opened accounts and recent credit inquiries. Having too many inquiries can jeopardize up to 10% of your score.
- And the fifth factor is the final 10%. It’s the number and types of accounts that you have, such as credit cards, auto loans, mortgages, home equity lines of credit, and retail accounts, for example. Having a mix of credit positively affects your score.
So let’s discuss how the simple act of canceling a credit card can reduce your credit score. You’d think that canceling a credit card would be one less account on your record, right? Well, the problem is that a card cancellation negatively affects three of the five credit factors that I mentioned. The biggest issue is something called “credit utilization”.
Keep a Low Credit Utilization Ratio
Credit utilization comes into play with the second factor--the number of credit accounts you have and how much you owe on them. Your credit utilization is expressed as a ratio of your credit balances to your available credit limits; it’s also called a debt to credit ratio.
Let me give you an example. If you have a credit card with a $4,000 credit limit and your balance is $1,000, you’re using 25% of your available credit. To calculate your credit utilization for any credit account, simply divide your current balance by the credit limit. For my example, the calculation is $1,000 divided by $4,000, which equals 0.25 or 25%.
There’s no specific ratio that FICO or the credit bureaus recommend, but the lower you keep your credit utilization ratio, the better. Many experts propose that you use 30% or less of your available credit to optimize your credit score. Any time your available credit limit is reduced, it increases your utilization ratio, which can negatively affect your credit score. So canceling a card--even one that’s paid-off--leaves you with less available credit. That increases your utilization ratio and causes your credit score to drop.
An important quick and dirty tip is to never max out all your available credit lines, even if you pay off your balance in full each month. It’s better to have two credit cards that each have balances below 30% of your credit limits than to have one card that you consistently max out. Keeping a good cushion of available credit can raise your credit score.