In part 1 of this series, we explored the pros and cons of closing your credit cards. Now, we want to explore the effects on your credit score, and what to consider before closing a credit card.
Effects on Your Credit Score
The effect a closed credit card account will have on your credit score depends on your credit history and on the current state of your balance/limit ratio.
According to the Fair Credit Reporting Act (FACTA) any negative history remains for up to 7 years or 10 years for a bankruptcy. This means that if you close an account with a terrible credit history, in seven years, the negative information will be erased.
While it may seem like a good idea to close a bad account and wait seven years for the information to be removed from your credit report, it is a better idea to work on turning that bad account into a good one by paying off debt and making each monthly payment on time.
Your balance/limit ratio is simply your credit card balance divided by your credit limit. For example, if you collectively owe $10000 and your combined credit limit is $10,000, your limit ratio is 100%. The lower your balance ratio, the better. AN unofficial rule is to have a 30% to 40% balance/limit ratio. The higher it is, the more you are seen as someone who will overextend themselves, spend oo much, and not be able to pay back.
Why is this important? It is important because lenders who are considering giving you credit or lending you money like to see that you are making good use of the credit you currently have.
What to Do?
Before deciding to close a credit card, take a look at your credit report and assess how closing the account will affect your score. By law, you are entitled to one free credit report a year. To access your credit report, visit AnnualCreditReport.com. Obtaining your score has a cost, but when you order your score in conjunction with your free annual credit report, the cost is often lower.
Remember, whatever your reasons for closing a credit card, the following are important reasons to consider for keeping the card open:
- If you have an inactive credit card or a card with a high balance, cut it up instead of closing it so that the history remains on your credit report but you won’t accumulate more charges on it.
- While the temptation to close an account in bad standing is high, closing it actually does more harm than good. It is better to pay off that account than to close it because closing the account decreases your credit score by increasing your balance/limit ratio.
- Be informed about the actions that can affect your credit score and act accordingly, and you’ll be a more attractive applicant to new lenders and creditors the next time you need to borrow mone
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