Some people, in an attempt to control their spending and get out of debt, believe that closing their credit cards is a smart financial move. But is it?
Having access to credit is actually of huge potential benefit. It’s how businesses are built and fortunes are made. It’s an indication that lending institutions have faith in your ability to make timely payments.
You can actually harm your credit rating by closing a long-standing card. The longer you can show a history of good credit, the better your credit score will be.
Of course there are ramifications of thinking your credit card is closed when you are actually carrying a balance. As well, if that credit card charges an annual fee, you might be surprised by a bill you did not expect. On the whole, you are better off keeping a credit card with zero balance and using it once in a while, and keeping a regular watch on your credit bureau as part of your overall financial management.
Likewise, having access to credit and a complete financial plan to achieve wealth is also a bigger benefit than closing a card. There are only a few times when it might make sense to close a card, such as when it could potentially interfere with other low interest, unsecured access to credit, but for the most part – keeping your cards and monitoring them is the wealth strategy I would recommend.
June 19th, 2008 at 2:07 pm
Thanks for addressing this point. We are constantly trying to help people understand the ramifications of closing credit lines.
A key part of each person’s FICO score, is the amount of access they have to open lines of credit, and how much they utilize that credit. For example, if I have access to $20,000 of credit, and I’m only using $5,000 of it, that’s good. The credit scoring algorithm
from FICO would figure my “utilization” as 25%.
However, if I close two credit cards at $6000 each so I’m not tempted to use them, now I only have access to $8000 dollars, but my balance may still be $5000. This is bad. Now the FICO algorithm says that my “utilization” is 62.5%. As a result, my credit score will likely drop, sometimes significantly, and now my credit card company can RAISE my interest rate because I’m perceived as a bigger risk, even though I’m trying to manage my credit wisely.
Here are a couple of generalities that we coach people on to have the highest scores possible. First, keep your credit lines open and use a minimum of 7% of the available line at least one time per year. Second, NEVER, if it can be helped, use more than 1/3 of your limit on any open line of credit. And finally, if you can, make multiple payments to your credit lines each month (total of payments must equal your “minimum payment due).
Of course, make sure that you have a plan.
Great thoughts MoneyMinding.
Travis Mitchell
Founder
Debt Free Project
http://www.debtfreeproject.com
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June 18th, 2011 at 2:00 am
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