People have lots of misconceptions about credit cards. Is opening more good for your credit score? Is closing a card good for your score? Do you want high limits or low limits? Do I need to use my card often to increase my score? Today, I’ll address one big misconception on whether or not it is a good idea to close a credit card.
30% of your credit score is determined by outstanding debts. The biggest factor in that part of your score is your credit utilization ratio.
Credit scoring companies think it’s bad if you max out your cards or use a super high percentage of available credit. Banks and lenders agree. To keep your score high, keep your balances low. 20% of available credit is a good reference point to use, though 0% is better!
For example, if you have a $10,000 limit on a card, you should always keep your balance under $2,000 to help keep your credit score high. But that 20% rule is not applied per account, it is across all revolving credit accounts.
If you have 3 accounts with a $3,333 limit (total of $10,000) and have a $2,000 combined balance, your ratio is 20%. If you close one but keep the $2,000 outstanding, your ratio just jumped to 30%, giving you a bad spot on your credit report.
Even if you never carry a balance, it can’t hurt having extra cushion for unexpected situations
Average Age of Credit
The average age of open credit accounts and length of your credit history makes up 15% of your credit score.
Every time you open a new account, it lowers your average age of credit. If you have an account open for a long time, it raises your average age. If you have an old account and close it, your average age of credit stops increasing and that account will eventually stop being counted in the average.
To keep your credit score high, keep your accounts open as long as you can. I usually charge something small, like a $5-$10 lunch, on each card 1-2 times per year to ensure they are still “active accounts” and are not at risk to be shut down by the credit card company.
BUT… There’s always a but.
As you read above, it is almost always best to keep your credit cards open, even if you don’t regularly use them. The big however is from annual fees.
If your card charges an annual fee, and you don’t use it, you are just throwing money away. Some cards are worth a fee if you are going to get a great benefit. I happily pay a fee on my Starwood American Express card because the benefits are so valuable.
If I did not get the value from the benefits, there would be no reason to keep the card open and keep paying for it.
Some banks will let you convert a card to one without an annual fee. That is the best option if you are able.
Why Do I Want a High Credit Score Anyway?
I just discussed two parts of what makes up your credit score, but there’s a lot more to it. Having a high credit score can mean the difference between whether you can buy a home or are stuck renting. I can be the difference between a low interest rate and a high one, which may cost you tens of thousands of dollars on a mortgage.
Do you have any credit score or credit card questions? Let me know in the comments.