Finances vs. Credit Part 1 of 4: Smart Financial Decisions That Hurt Your Credit Score
by Jenna
Question: Let’s say you have a credit card that you’ve had since your college days. It has a relatively high interest rate, and a whopper of an annual fee. Your credit has improved since then, and you are now eligible for far better offers. What do you do?
Financial Answer: The smart financial decision is to close the old, unused account, and then open up a new credit account with a better interest rate, and some decent rewards. This way you benefit from your improved credit rating instead of paying a high interest rate and yearly fees on a card you no longer want.
Zing! Yup - You guessed it, you just lowered your credit score…
Why closing that old account will lower your credit score:
Your credit score is based on several factors, and closing an old account affects two of them:
- How long your accounts have been open - Closing that old, unwanted account is going to lower the average age of all your open credit accounts, and that will lower your score.
- The total amount of money you have borrowed, vs. the amount of money you are capable of borrowing -
Credit Score Rundown: The length of time your accounts have been open is 15% of your total score.
When lenders consider your creditworthiness, they want to know how much you currently owe on everything - credit cards, mortgage, car payment, everything. Then they compare it to your total lines of credit. Basically, they want to see that you are not actually using more than 20% - 30% of all your available credit lines.
If you close that old, paid off account, then you will appear to be using more of your total available credit than you were before you closed the account - especially if you are carrying revolving balances on any of your other credit accounts. This will lower your credit score.
Credit Score Rundown: Available credit vs. used credit is 30% of your credit score.
So what do you do? You choose your own adventure!
Choose your Credit Score First:
If you are actively trying to raise your credit score, then leave the account open, make a small charge on the card every few months, and pay it off to avoid the high interest rate. Unfortunately, you will have to chalk the yearly fee up to the cost of raising your credit score.
Quick Tip: Call your credit card company. See if they can waive the annual fee, or reduce the interest rate. If your credit history with them is good, they may be more willing to help you than you think!
Choose Your Finances First:
If your goal is to streamline your accounts, and get rid of additional expenses like the high interest or yearly fees, then go ahead and close the account.
Quick Tip: If you are planning to apply for a new credit account any time soon then make sure you have the new card in hand before you close the old account - that way your credit score will be highest when you apply for your new card, and you can get the best deal possible.
Check back with us Monday for part two of our Finances vs. Credit series!
What’s your 2¢? Leave a Comment Below!
June 27th, 2008 at 4:41 pm
I disagree. The effects of closing an account are greatly exaggerated. When an account is closed, it stays on your credit report for 10 years. So you will not see an immediate drop in your credit score due to age. Let’s say the account you’ve had since college is 10 years old. You have another account that’s 1 year old. Your average age is 5.5.
In 10 years, right before the account drops off, you will have 2 accounts whose ages are 20 and 11, for an average age of 15.5. After the old account drops off, you will have a single account whose age is 11. So your average age drops from 15.5 to 11. Big deal. In 10 years, hopefully, you have established a good credit record, paying everything on time, etc. This change will barely have an effect.
I agree that normally, there is no huge advantage to closing an account. Just cut up the card if you don’t want to use it. But if you are being charged an annual fee, then go ahead and close it.
Another option is to call the bank and see if they can transfer you to a different product. Usually a bank has many different credit card programs, some with a fee, some without, and with varying interest rates. If they transfer your account, you will retain the credit history.
As for the utilization, yes, that will immediately change if you close an account. But again, big deal. If it has a $5000 credit limit, just apply for another account or 2 to increase your total credit limit.
Don’t do any of this if you’re planning to apply for a mortgage or anything like this within the next 6 months. But normally, these actions should not have any long term effect on your credit score.
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