How Closing Your Old Credit Cards Really Affects Your Credit Score

Like the majority of other money-conscious folks out there, I was also one to believe the long preached advice to not cancel your old credit card accounts because the credit history of that account would disappear from our credit report.

We don’t want to see our squeaky clean credit repayment habits wiped off our reports so we follow the widespread convention of cutting up the old plastic or putting them in the back of the freezer.

Luckily, Craig Watts, a spokesman for FICO, has come out to debunk the financial myth.

Positive credit history remains on your credit report for 10 years while negative credit history sticks with you for 7 years. Information from closed credit card accounts still plays a factor in calculating the “payment history” portion (35%) of your credit score. Another 15% of the credit score consists of the length of your credit history, which will still account for the age of the closed accounts.

While this may come as a relief to those who have been on the fence about officially closing their old credit card accounts, canceling your old, unused credit cards doesn’t mean that it will have absolutely no effect on your precious credit score. Depending on your financial situation, how much your credit scores suffers will vary.

Your Credit Score Can Still Take a Hit
Disproving this once-universal belief of closing old credit cards doesn’t not solve the headaches and worries of those who still carry major credit card debt. The FICO credit score takes the debt-utilization ratio into account – comprising a whopping 30% of your credit score. Also, known as the credit-to-limit ratio, the debt-utilization ratio is calculated by dividing your total outstanding debt by your total available credit.

Closing an old credit card account will mean that you are decreasing your total available credit – and if you’ve had it for a long time, you may have a large credit line. If you are carrying a ton of debt and you cancel a credit card, it will make a significant dent to your credit score because the debt-utilization ratio went up.

• If you have a balance of $2,000 on credit card A with a credit line of $5,000 and no balance on credit card B with a credit line of $5,000, your debt-utilization ratio is 20%. Closing credit card B would change your debt-utilization ratio to 40% and therefore, would hurt your credit score.
• If you have no balance on credit card A with a credit line of $5,000 and no balance on credit card B with a credit line of $5,000, your debt-utilization ratio is 0%. Closing either one of the cards would still result in a debt-utilization ratio of 0%.

To Minimize the Damage
So, the announcement would be of great news to those who are already debt-free and are looking to rid themselves of the potential to become repeat victims of credit card debt. Since the largest impact of closing a credit card account seems to be on the credit-to-limit ratio, it would be best to close the account when you have zero debt (yes, quite an impossible feat for many). With no debt, your debt-utilization ratio would be 0% whether your total available credit is $100,000 or $100.

Even if you have a small amount of credit card debt, closing a card of two shouldn’t do much harm – especially if it acts as a psychological stepping stone towards your goal of becoming debt-free.

(Photo credit: kainr)

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