What happens to your credit score when you negotiate a hardship interest rate reduction, and close your credit account?

A reader, Elizabeth, asked this question:

I have negotiated a hardship rate reduction with chase from 29.9% to 8% for 12 months. I have a good history with this institution. I think that i will be able to pay more than the minimum payments and reduce my overall balance faster. The only stipulation is that I voluntarily close this account. The balance is $6500 and the limit is $7000. I have 5 other credit cards with substantial limits that are also almost maximized. Is this going to hurt me more that help me?

Elizabeth

Elizabeth,

This is a situation where you will need to decide what is most important to you. I can tell you that any time you close out a credit account it hurts your credit score. Especially if you have other cards with high revolving balances.

However, sometimes your credit score really doesn’t matter in the greater scheme of things. It helps if you think of it this way:

The credit bureaus are businesses. The banks that lend you money via credit cards are businesses. They are out to make the largest profit they can.

Your credit report, and your credit score are tools designed by those companies. As such, they are a little biased. Things like closing out credit card accounts, while financially the smart things to do, are discouraged. Never charging on your cards is also discouraged. (The only way to raise your credit score is to use your cards and make timely payments..)

Sometimes the financially intelligent thing to do is the exact opposite of the “right” thing to do as far as your credit score is concerned. Want to shop for credit, and get the best deal? Your credit score gets dinged. Want to close out an old account with a company that’s treated you horribly? Your credit score gets dinged.

Want to consolidate your debt, pay it down, negotiate it around? It has a price – your credit score can go down.

The good news is, it’s very easy to raise your credit score back up! FICO relies much more heavily on recent information when they factor your score. They do take the previous seven – ten years into account, but what you have done for the last couple of years matters the most.

So, if you want to take this time to focus on paying your debt down, there really isn’t anything wrong with that. Even if it lowers your credit score, you end up with a fresh start once your debt is gone. There are actions you can take to protect your credit score during this time as well.

How much will this affect your credit score?

FICO guards it’s formulas pretty closely, so it’s impossible for me to tell you a specific number of points here. But, I can tell you that your score will definitely drop. Here’s why:

30% of your credit score is based off of your total available credit vs. the amount of debt you have. When you close this account out, your total available credit will drop, but your debt will not.

15% of your credit score depends on how old your credit accounts are. Once that account is closed, it will no longer be helping to raise that 15%.

There is good news though:

The biggest percentage of your credit score (35%) is made up of your payment history. As long as you keep making your payments on time each month, then that 35% will help protect your good credit score.

Something to keep in mind too – these percentages I am quoting – it does not mean that your credit score will drop by thirty percent, etc. It just means that the one account you are closing factors into that 30%, along with all of the other accounts and payment records that you have.

My best advice (and I am not a financial advisor, it’s just my opinion) – don’t worry about it. Get rid of your debt. Keep paying your bills on time whatever you do, and work on reducing your balances. As your debt goes down, your credit score will go up (since you are no longer using as much of your available credit!) and the situation should pretty much repair itself.

If you want to keep a close eye on the situation, you can monitor your FICO score for around $90 a year. (They bill it monthly or yearly). That way you can track your score, and see the initial credit score drop, as well as the recovery as you lower your balances and make your payments on time.

Thanks for your question!

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Keep Reading:

• Should You Use A Credit Monitoring Service
• The FICO® Score Breakdown
• Understanding FICO Score

Thanks also to these carnivals who featured our articles this week:

• The Carnival of the Vanities and The BOMS at Dodgeblogium
• Money Hacks Carnival #60: The File Your Tax Return Edition @ The Consumer Boomer
• Carnival of Twenty Something Finances – DC Edition @ Your Money Relationship
• 15th edition Book Review Blog Carnival @ MYSTERIES IN PARADISE
• Book Marketing Blog Carnival – April 15, 2009 @ Selling Books

This entry was posted on Saturday, April 18th, 2009 at 06:32 and is filed under Credit Score Repair FAQ. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.