Question
I recently closed out some credit cards after a friend had told me that I should. But I recently read on the Internet that this was a bad thing to do. Is this true?
Answer
Well, sort of. This answer has several parts. Closing out fairly new cards is not as bad as closing out older accounts. Closing out old credit card accounts is not always a great idea and here’s why. One factor that does into how our credit scores are calculated is the age of an account that has good credit history. Said in another way, if you have an older account that you have paid perfectly then your credit scores will be positively affected with keeping this account open.
Keep Accounts Open And Active
One thing that you want to be aware of is when keeping a credit card account open for a long time is that you want to also use it from time to time. Credit card companies do not like seeing open unused credit accounts on their books. They will close your unused open accounts for inactivity. This is bad for you for two things. One is that your good credit history with that account will not get as much weight as it did when it was open which could lower your credit scores. Second, closing this account either by you or the credit card company could impact your debt to limit ratio.
What Is My Debt To Limit Ratio?
Your debt to limit ratio is simply your credit card limits all added together as compared to your total debt owed on those credit cards. Let’s take an example to make this crystal clear. Pretend for a moment that you have 3 open credit cards. Credit card 1 has a credit limit of $5,000 and a balance of $3,000. Credit card 2 has a credit limit of $3,000 and a balance of $2,500. And Credit card 3 has a credit limit of $4,000 with a balance of $1,000 on it. If we add these balances and limits up you have a total credit limit of $12,000 and a total balance of $6,500.
Now let’s calculate your debt to limit ratio. To do this, we simply take the total balance of $6,500 and divide it by the total credit limit of $12,000. This equals .54. Not bad, but for better credit scores you will want this figure under .5.
Now let’s look at what happens if you payoff credit card 3 and close the account like your friend told you to. What happens to your debt to limit ratio. By paying off credit card 3 your total debt on the other two cards is $5,500. And if we total up your credit limits on the remaining two cards we see a total limit of $8,000. Again, let’s calculate your debt to limit ratio now. We divide the debt by the limit - $5,500 by $8,000 to get .69. Yikes this is worse. This ratio is worse than when you had three credit cards, which is contrary to what makes sense to a lot of people about their credit situation.
So my bottom line answer to you is closing accounts is not necessarily good. My recommendation to you is that you keep your cards open and keep using them on a very limited basis. And, tell your friend to read this question. No offense to your friend, I'm sure they were just trying to be helpful. For more ways to improve your credit scores visit: Credit Repair – The Basic Steps To Do It Yourself.
