Why Closing Credit Card Accounts Can Hurt Your Credit Score
Most people don't know that closing credit card accounts can hurt their credit score. However, according to this article by Adam Levin, this is one of the biggest mistakes that a consumer can make.
Obviously, not paying your bills is the biggest mistake, but cancelling your credit card accounts can also hurt you. This is because your credit score relies heavily on positive credit histories and your credit utilization.
If you close a credit card account, then you will lose the positive credit reporting once that account drops off of your credit report. On the other hand, an open account will remain on your report so long as it is open. This means that even if you do not use a card, its past positive history will remain on your report and help your score in the long run.
Additionally, closing an account reduces the total amount of credit that is extended to you. This may seem like an attractive idea if you are trying to protect yourself from your spending habits -- it is hard to get into a deep credit hole if you don't have much credit. However, roughly 30% of your credit score is based on your credit utilization -- the ratio of debt to available credit.
This means that closing credit accounts can actually hurt your score -- by closing open lines of credit, you reduce your available credit. This means that any debt you have has a larger effect on your credit utilization because there is less unused credit to balance it out. Quite simply, closing a credit card can turn a 10% credit utilization ratio into a 40% ratio.
Consumers trying to repair their credit after a bankruptcy will most likely have very little choice about leaving credit accounts open. The bankruptcy takes care of those accounts. However, the advice in Adam Levin's article is good advice for the long term.
Once a consumer receives a bankruptcy discharge, new credit card offers often follow. This is because the banks know that there are limits on how often a consumer can file for bankruptcy; a new credit card account will stay "on the hook" for quite some time.
As a consumer's credit improves, more credit card offers will come. Accepting some offers makes sense because those lines of credit will add to the total amount of credit available. So long as the balances on individual cards stay relatively low, then the credit utilization ratio should help improve the overall credit score.
Learning how to use credit effectively is an important skill for anyone seeking to improve or repair a credit score. You can read more about credit repair in this blog post and this post.