Closing Credit Cards?

Most folks realize that credit scores are important, but many don’t realize that common misconceptions may cause some to unknowingly lower their own score.  The issue of “too many credit cards” was one example which surfaced at recent seminars I taught at ING Direct Cafés in New York and Philadelphia. Most folks commonly assume it’s bad to have “too many” cards, and therefore should close those seldom used. This could be true, but then again, it could be wrong. First of all, like everything with credit scoring, there’s not one magic, “correct number” of credit cards. It all depends, because data on your credit cards is weighed against all other data in your credit report. But, it’s important to know that closing credit cards can lower your score.  Here’s why.

•  30% of your FICO score is based on credit utilization, that is, the ratio between your balances and credit limits on your revolving credit. Cards are scored one at a time and then again collectively
•  15% of your FICO score is based on length of credit history.

When you close credit cards you reduce your credit limits and eliminate potentially helpful length of history. A separate analysis, unrelated to FICO scores, sometimes is made by mortgage lenders who see that a mortgage applicant could seriously change the debt-to-income ratio if the applicant used all of the available revolving credit. Even so, most mortgage lenders look at the FICO score first, so tread carefully.

There will be another seminar at ING Direct’s Los Angeles Café on Thursday, Dec. 1. (11175   Santa Monica Blvd., @ I-405 Exit)  Evan Hendricks is Author of, "Credit Scores and Credit Reports: How The System Really Works, What You Can Do"

   

Comments

[JohnUlzheimer]

Very nice comments Evan. "Close unused or underused credit card accounts and it will help your FICO scores" is by far the #1 piece of incorrect advice that consumers are given. It's so important to understand what you've done that I decided to spend some time expanding on your excellent explanation...here goes.

1. The example "Too many credit cards" comes up because it is a paraphrase of one of the FICO score "adverse action" codes (more commonly referred to as "reason codes"). In fact, that language is actually "Too many bank/national revolving accounts" which gets translated into "too many credit cards." In this case the translation is correct.

Interestingly, there are several reason codes that show a penalty for too few of these same accounts or no recent activity on these types of accounts. Point is that you can be penalized for having too many OR too few OR no recent use of these types of accounts. A frustrating fact for sure for consumers who want to optimize their credit use and scores.

The point I want to make on this one is that the reason code doesn't say "too many OPEN credit cards." When a consumer closes a credit card (or other revolving account) it doesn't go away. It's still on the credit report so they aren't positively addressing "too many." All they did was close it...it's still there and will be for years to come. They didn't do anything to help themselves.

2. The more important issue here is clearly the negative impact to their utilization percentage. Here's a very realistic example of what happens.

John walks into a mortgage broker's office and applies for a loan. His scores are ok, but not good enough to qualify for the best rate. He needs a few more FICO score points. His mortgage broker advises him to close a few credit card accounts and that should do the trick. Let's do the math...

Say I have 5 credit cards and each has a $2000 credit limit. I have a $10,000 aggregate credit limit.

Now let's say that I have a $2000 balance on 2 of those cards and a $0 balance on 3 of them. That's a $4000 aggregate balance. My aggregate revolving utilization is 40% ($4000 divided by $10,000).

If I closed those other 3 accounts that are unused the FICO scoring model pulls those closed card accounts out of the equation. So now I have $4000 in aggregate credit limits and $4000 in aggregate balances. I just went from 40% utilized to 100% utilized. I also just went from an A- borrower to non-prime.

And there's no easy way to correct what just happened.