Understanding Credit Cards and Your Credit Score
Your credit score is determined by your payment behavior when it comes to paying credit cards, and other types of loans or debts. The five major factors calculated into a credit score are:
- 35% of your score is determined by payment history (This factor includes any judgments, bankruptcies or foreclosures.)
- 30% of your score is determined by your debt to credit ratio
- 15% of your score is determined by the average age of your credit history
- 10% of your score is determined by the types of credit you use
- 10% of your score is determined by the number on inquiries (requests for new credit)
Closing old cards can impact the debt to credit ratio, the average age of your credit history, and the types of credit you use.
Debt to Credit Ratio
A debt to credit ratio is determined by how much available credit you have for use. If altogether you have 4 credit accounts, each with a $250 limit, then you have $1000 of available credit. If you have charged $500 across your cards, your debt to credit ratio is 50 percent.
If you close old accounts that don’t have a balance, or that have a high limit, you can raise your debt to credit ratio. For example, if you closed the two accounts that you haven’t charged anything on, your debt to credit ratio would rise from 50 percent to 100 percent.
A higher debt to credit ratio sends a signal to lenders that you are maxing out the cards and may not be living within your means. It makes lenders wary that you will be unable to pay the debt you have incurred. As a result, closing accounts raises a debt to credit ratio and this can lower your score. Most experts recommend that a debt to credit ratio is kept at about 30 percent, so keep those old cards open and just don’t use them at all.
Average Age of Accounts
Closing cards that you don’t use any more can lower the average age of your credit accounts. A longer credit history indicates that you have been using credit responsibly for a longer period of time. The longer a credit history, the more information a lender has to base your credit score on.
Make sure that old cards don’t get closed due to inactivity either. Some lenders will close old cards for you if the cards are unused for years on end. This too can hurt one’s credit score. Make sure this doesn’t happen by charging a pack of gum or some other very small charge on your old cards once a month. Be sure to pay it off right away and then put the card away for the month.
Types of Credit
If you close old accounts and they were accounts with major lenders, it can also hurt the factor of your credit score that deals with types of credit. While lenders primarily like to see a mix of mortgage loans, car loans and credit cards, they also want to see that you have been entrusted with credit by major lenders. Closing old accounts can reduce the types of credit available to you, thus hurting this factor of your FICO score.
What to Do With Old Credit Cards
Since the answer to the question, “Does it harm your credit score if you cancel or close credit card accounts?” is yes, avoid closing old accounts. Keep the cards in a safe place and make a commitment not to use them, except for periodic, very small purchases. If you are worried about the temptation of charging on the cards while trying to remain debt free, freeze the cards in a block of ice in the freezer or place them into a safe deposit box at the bank so they will not be as accessible. Just do not close them, or you could unknowingly damage your credit in the process.