What happens to your credit score when your credit card company closes out your credit card account?

A reader, M., had this question:

I have recently received notice that one of my credit cards was closed due to high balances and several inquiries even though I had never been late and last month paid off half of the balance.

There is a still a balance due that I am scheduling to pay in 2 weeks approximately. How can I handle this? Should I just sacrifice the other cards and pay this one in full since it is already closed or make payment arrangements?

I am hoping to improve my credit to buy a house hopefully by the end of the year. Almost forgot. Last month I have being car shopping that’s why the inquiries total of 4 shown on my credit.

Thanks for your question M.

There are several factors that will affect your credit score here, so let’s take a look at them one at a time.

Being over the limit, or near the limit:

Being over the limit, or near the limit on your credit cards will damage your credit score. If your account was closed because you went over your limit, then it’s a very good thing you paid half the balance off. I hate that this happened, but the credit card companies have really been tightening their belts lately, fewer people are getting approved for loans, and many people are having their accounts closed or their interest rates raised.

Why does it matter if you go over your limit?

Coming close to, or going over your limit effects your Debt – to – Credit Ratio. (How much you can borrow vs. how much you have borrowed.) This number is 30% of your credit score. The more cards you have maxed, or nearly maxed, the more it is going to hurt your credit score.

Another problem:

When your account was closed your total available credit dropped. Since you can no longer borrow money on that card, you appear to be using more of your credit than you previously were.

An Example:

Before the account was closed, let’s say that you had $1,000 of available credit on this card. You had charged it to the limit – $1,000. You then paid half the balance – $500.

Let’s also say that you have three cards with a total of $2,000 available credit between all of your credit accounts, and your other cards were near the limit too.

When that account was closed, your total available credit was cut in half – but your debt wasn’t. You now have a total of $1000 in available credit, but your total debt would be $1,500.

This is what effects your credit score. The only way to fix it is to pay down your total debt as fast as possible.

The Inquiries:

Having multiple inquiries on your credit report does lower your credit score. It looks like you are shopping for credit. However, auto loans and home loans work a little differently. According to FICO, multiple car or mortgage inquiries that do not generate multiple loans are weighted differently. That is because they assume you are going to shop around a little before you settle on a loan. So, in your case the inquiries are probably not what hurt your score.

So what should you do now?

If you really want to raise your credit score enough to be able to buy a house by the end of the year, then you will need to follow this plan of action. It will wake time, and persistence, but it will fix your credit.

Step 1: Call Your Credit Card Company About Your Closed Account.

You will want to speak with a manager, right from the start. Ask for the following things:

• Can you re-open my closed account? They probably will not, but it is worth asking for.
• Can you remove any of the late or over the limit fees on my account? Tell them the fees are killing you. Make a payment that day in order to get the fees removed if you need to.
• Can you lower the interest rate on my account? Always worth asking for, at least once. Don’t be afraid to tell them that you are planning to balance transfer your debt if they cannot help you. (Even if you don’t plan to. Your account is already closed, so you have nothing to lose.) Generally by the time a credit card company closes your account, they have hiked your interest rate to the highest rate they have. They can lower it for you, just be persistent.
• Can you make payment arrangements with me? If you are past due on the account, they will make payment arrangements with you. If you are not past due on the account, there is no need for an arrangement, just pay what you can each month to get the account paid off.

Step 2: Repeat this with all of your current credit card accounts

Lower interest rates, fewer fees, etc. will only make paying off your debt easier. With your current credit accounts, you should also ask them to raise your limit. They may not, but if you can get them to do it, then it will immediately boost your credit score a little.

It is important to increase your existing limits if you can, but do not apply for any new credit at this time – that will just hurt your credit score.

Step 3: Track your credit scores.

You can either purchase a credit score monitoring service though FICO, or through one of the three main credit bureaus. I recommend getting it directly from FICO. You can get a free 30 day trial of FICO’s score watch here. After the free trial it will cost you around $90 a year to monitor your score. You can call them though, and have them bill it monthly instead.

It is an expense, but since you are considering purchasing a home I do recommend it. FICO will also help match you with available lenders once your score is high enough.

If you actively work to raise your credit score, then the $90 is worth it – you will end up saving far more than that because your credit scores will go up. You will get a return on that investment when you qualify for a reduced interest rate on your mortgage.

Step 4: Get copies of your current credit reports

You can get copies of all three of your current credit reports by visiting Annual Credit Report.com

Make sure you get copies of your reports from all three credit bureaus, Equifax, TransUnion, and Experian. Once you have your current copies, sit down and highlight any negative information. Are there items listed that you can challenge and have removed?

By law, if you challenge something on your credit reports, then the company that reported the item has 30 days to validate their claim. If they do not, then the item must be removed from your credit report.

Do not challenge too many items at once, since this will backfire and cause your credit report to be frozen. Challenge one or two items per month, at the most. For a step-by-step guide on how to do that, you can check out this article:

If you are tracking your credit score, you will be able to see it go up as the challenged items come off. Each time you challenge something, you are entitled to a new, free copy of your credit report, so you should never have to pay for that.

Step 5: Pay down your balances

This is crucial, and it will have the biggest impact on your credit score aside from the disputes you will make. Pay down your balances as fast as you can, and do not continue to charge on your credit cards. This is the best thing you can do if you want to qualify for a home loan at the end of the year. It takes time to raise your credit scores – months and months of low balances and on-time payments. Challenging things will boost your credit score, but how much you owe is still going to matter.

So, what should you pay off first?

This is from the FICO Credit Education Center:

Keep this in mind: This credit usage ratio is one of the most important factors to your FICO score, so you should work on paying down your balances. Your FICO score looks at the ratio of revolving debt, but not in which accounts the debt resides. Therefore, consolidating or moving your debt from one account to another will usually not help your FICO score since the same total amount is owed.

So, essentially they are saying that your total debt is the only thing that matters. If that is true, then it doesn’t matter which account you pay off, just as long as you pay them off.

However, FICO scores are notoriously complex. The fact that the account has been closed could affect things. You have a couple of options here:

• You can pay off the closed account and be done with it - This is emotionally good, because the account being closed was a negative experience. All the fees associated with the closure, and the corresponding interest rate hike is also bad.
• You can pay off the account that has the highest interest rate - After you call your credit accounts to have your interest rates reduced, you can pay off the one that is costing you the most in interest each month. This is financially savvy. The more money you save in interest, the more you can pay on your other accounts each month.
• You can pay off the account that is closest to it’s credit limit first - This is probably the best path. If you have accounts that are over the limit, or very near the limit, whether open or closed, paying them off first will boost your credit score.

How much of your balance should you be using each month if you want to raise your credit score?

If you want to see the biggest increase in your credit score, pay all of your balances down to under ten percent of your available credit. People who have the highest FICO scores statistically only use 7% of their available credit each month.

If you are trying to raise your credit scores you do want to use your cards though – don’t pay them all off and stop using them. Just pay them off, and then charge a very small amount on your cards each month.

This allows you to show that you can use credit responsibly, and it also lets you make regular on-time payments. Those payments get reported to the credit bureaus each month and help raise your score.

Thanks for your question!

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This entry was posted on Thursday, April 2nd, 2009 at 07:47 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.