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How does closing a credit card affect credit score?

By Leslie McFadden · Bankrate.com
Monday, March 29, 2010
Posted: 12 pm ET

A few weeks ago, I wrote about Citi imposing a $60 annual fee on some credit card accounts. Even a few of my colleagues received the notice, which explained that they could either cancel the account to avoid the fee or get a refund by spending $2,400 on the card over the next 12 months.

Source: FICO

Frustrated by the new fee, my colleagues, as well as several Bankrate.com readers, declared their intent to close the accounts.

Some people asked me whether the account closure would damage their credit score.

It's been a little while since I spent some time explaining the possible impact, so here goes.

The answer: Maybe, maybe not. It won't boost your score.

Length of credit history

You may have heard that closing accounts shortens your length of credit history, which is worth 15 percent in the FICO score model. Other scoring models exist, but I'll use FICO as the example since it's the industry standard.

The reality: Closing an account doesn't automatically forfeit years of good payment history. Accounts in good standing can stay on your credit report for up to 10 years, and those with delinquencies will remain for up to seven years.

In other words, the closed account probably won't disappear for some time. (Which makes sense, otherwise people could just close their accounts to hide late payments.)

Utilization increase

Behind payment history, how much you owe comprises the second most important factor in the calculation of FICO scores. This category of data includes overall utilization, which is the sum of your balances divided by the sum of your credit limits. Closing accounts can increase your utilization and lower your score.

The FICO score doesn't factor the balance and limit of a closed account into utilization once the cardholder has paid off the account. A lowered credit limit by itself won't take away points because credit limits are not a standalone factor for FICO scores.

If you keep low balances on your other accounts (that doesn't mean you actually have to carry a balance), the impact of closing one card out should be minimal.

For example:

If you have two credit cards, one with a zero balance and $1,000 limit, and another card with $200 charged to it and a $1,000 limit, and you close the one with no debt, your overall utilization would go from 10 percent to 20 percent.

If however, you had $800 on the second card, your aggregate utilization would shoot from 40 percent to 80 percent.

It's impossible to say exactly how much a score will drop from increased utilization (since the actual algorithm is proprietary), but the higher this ratio climbs, the greater the damage to your score.

If you have high balances on other cards when you close an account, your utilization could climb and ding your score. As soon as you start to pay down those other balances though, your score should improve. Past high balances won't penalize the score for years to come, as delinquencies and other credit missteps do. Credit scoring models use the most recent balance and limit reported by the lender.

Advice

Pay down other balances to protect your score if you decide to close an account due to an annual fee. If you pay in full every month, this advice translates to charging less on your other cards. Issuers may still report a monthly balance even if you pay the entire bill each time.

Use our free FICO score estimator to see where you stand.

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1 Comment
Jeff
April 22, 2010 at 6:16 am

Pretty good article. I have only one comment....who cares about the almighty fico? All fico shows is how well you deal with debt...how long you had it, how religiously you pay it, and how much you carry at any time. I would rather pay cash for things and live within my means than to go into debt again for anything. Your income is your best wealth building tool and when you wasted on interest charges and paying for things you no longer play with it's not building wealth.