This is one of the most misunderstood aspects of credit. What you may find surprising is that closing credit card accounts can hurt your credit score almost as badly as missing a payment. There are two important reasons why you should not close credit card accounts:
A). Length of Credit History: Your length of credit History is 15% of your credit score. You want to have long-standing, positive credit card history. The information in your credit reports are subject to certain rules regarding how long accounts can remain on your credit report. Once you close an account it will eventually fall off of your credit report – removing that credit history with it. If however you leave the account open and use it periodically, making timely payments, the account will remain active and continue to report on your credit.
Why do you want accounts to remain open and reporting? It’s simple – long-standing, positive credit accounts have a positive impact on your credit scores. So, what should you do with old credit cards that you don’t use any longer? What you don’t want to do is to let the account become inactive. When this happens, the credit card companies aren’t generating any revenue from your account. Eventually, they’ll close the unused account because you’re more of a liability than an asset. You can prevent this from happening by using the card every few months for low dollar purchases like dinner or a tank of gas. When the bill comes in, just pay it in full. If you do this, it will ensure that the account will never be closed and your length of credit history will continue to grow!
B). Credit Utilization: The percentage of your available credit in relation to the debt you owe is what is called “credit utilization” or “debt to credit ratio” and this accounts for 30% of your credit score! To calculate this you divide the total balance by the total available limit. For example, if you have an open credit card with a $1,000 credit limit and you have used 50% of the available credit on this credit card, then you have 50% credit utilization. Now let’s add a second credit card to the mix. Let’s say you have another open, but unused credit card account with a $1,000 limit and a $0 balance. This would give you a total of $2,00o in available credit with $500 in credit balances, putting your total credit utilization at 25%. It is ideal to keep your credit utilization below 30% to maximize your credit score.
So how will closing unused credit cards hurt your credit utilization? When you close an account, the amount of available credit decreases, which could result in a higher credit utilization and lower your score. Let’s use the example from above and close the second unused credit card account. When you close the account, you remove it from any utilization calculation and now you’re stuck with one open credit card account with a $1,000 credit limit and a $500 balance. This caused your utilization to go from 25% to 50%. As your utilization percentage increases, your credit score decreases. When you’re talking about several unused credit cards with high limits, you can just imagine what closing credit card accounts could do. I’ve seen consumers go from a 10% utilization to almost 100% utilization because they closed all of their credit card accounts except the one they were currently using. Keeping your cards open and active can help you avoid this credit pitfall.