If you are about to pay off and close a credit account, make sure you read this article first:

A reader, Stephen, had this question:

I have a Capital One credit card and they just informed me that they are increasing my APR. Will it hurt my credit score if I pay it off and close it out to avoid outrageous rates?

Stephen

Thanks for your question Stephen.

When you pay the account off, your credit score will go up, but if you close the account, it will lower your credit score.

Why does that happen?

Why your score goes up:

Your debt – to – credit ratio (How much credit you have total, vs. how much credit you have used) is 30% of your credit score. When you pay off the card you will be using less of your total available credit, so your score goes up.

Why your score will go down if you close the card:

Closing the card hurts your score by negatively impacting your debt-to-credit ratio.

If you are carrying a balance on any other credit cards at all, it would be best to leave this account open, but not charge on it. When you close the account, it lowers your total available credit. As far as your credit score is concerned, it will look like you are suddenly using more of your credit than you used to be because the credit line on that card is no longer available. Wacky, huh? You do the right thing financially and it lowers your credit score.

Here’s an example:

If you have $12,000 worth of credit available, and you have $6,000 of it charged, then you are using 50% of your available credit.

Here’s the FICO trick: Say this Capital One card had a $3,000 limit. If you pay off the card, your total debt would be down to $3,000, and you would still have $12,000 total credit available to you. That means you would be using 25% of your available credit.

So what happens if you cancel the card? If you cancel the card, you would only have $9,000 of available credit and be using $3,000 of it. That is about 33% of your total available credit. You didn’t go out on a spending spree, but to FICO and the credit bureaus, it looks like you did.

So what can you do?

Well, if you aren’t carrying a balance on your other cards, and you really, really want to close this one, your credit score should recover. If you are carrying a balance on anything else at all, try to wait to close this account until you have the rest of your debt paid off.

In the meantime, you can consider these options:

Give Capitol One a call. Tell them you are very unhappy with your rate increase, and you are thinking of balance transferring your debt to another company. Ask them if they can make you a better offer. Do not tell them you are thinking of closing the account at this time, or you will be stuck with the higher interest rate permanently.

If there are yearly, or monthly fees on the card, ask to have them waived. If there are late, or over the limit fees on the card, ask to have them removed.

If you can negotiate a better deal with Capitol One, so much the better. If you can’t don’t be afraid to pay that debt right off to avoid the interest, or to actually balance transfer to something with a better interest rate.

How much of a hit will your credit score take if you do close your Capitol One credit account?

It’s impossible to say, because it depends on so many factors like how much debt you have, how long you have had your credit card accounts, which types of credit accounts you have, and the list goes on.

I can tell you though, that if you continue paying down your debt, your credit score will recover from closing this account. Just don’t close it out if you intend to get a loan this year, or if you have any other revolving debt at all. That is the safest practice as far as your credit score is concerned.

For more information on how FICO scores are calculated, you can check out this article:

Thanks again for your question.

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This entry was posted on Thursday, March 26th, 2009 at 08:37 and is filed under Credit Cards 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.