Closing Credit Accounts: Considerations & Potential Impact
There can be a lot of confusion and misinformation when it comes to credit scores. Find out how closing a credit account impacts your score.
Your credit score is based on how you manage your credit accounts, such as credit cards, mortgage loans, car loans, personal loans, or a line of credit. There are many reasons why you’d want to close a credit account; perhaps you don’t use the account anymore, you don’t want to pay the annual fee, or you’re ready to upgrade to an account with more benefits.
Before you rush to close an account, here are some considerations for how it could hurt your credit score.
Credit Utilization Ratio
Under common credit scoring models, your credit utilization ratio, often expressed a percentage, impacts 30% of your credit score, making it the second most important factor. This ratio is determined by the revolving credit you’re currently using, such as a credit card or line of credit, divided by the total amount of credit available.
For example, if you have a total of $10,000 available credit on two credit cards and a balance of $5,000, your credit utilization ratio is 50%.
A lower credit utilization ratio shows you’re using less of your available credit. When closing a credit account, your credit utilization ratio will rise because of the reduced available credit. It’s recommended that you keep your utilization under 30% – the lower the percentage, the better.
Using the last example, if you cancel one of those credit cards, your utilization rate will increase provided your outstanding balance stays the same.
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Length Of Credit History
The third most influential credit score factor is the length of credit history. Having rich history is beneficial because it helps lenders assess risk and predict how likely you are to make payments. Closing an account, especially an older account of yours, will impact the average age of your accounts.
Keep in mind, all closed accounts in good standing remain on your credit report for 10 years while those with negative marks generally remain for 7 years. Whether or not closing an account will immediately impact this area depends on the scoring model. The VantageScore® model, for example, doesn’t factor closed accounts in; FICO®, on the other hand, considers closed accounts that are on your report.
In contrast, both credit scoring models factor in a closed account’s payment history as long as the account is reported. This generally makes up 35% of your score, making it the single most important credit score factor. A solid payment history will continue to help your score, but it becomes less impactful as the account history ages. This is helpful if you have negative remarks, such as late payments.
It’s good practice to view your credit report to check for errors, especially after closing an account. Example of errors include late payments, inaccurate balances, accounts showing as open when they’re not, and having some else’s information reported (known as a mixed file).
You can dispute any errors with the credit reporting company you pulled your report from, but it may take up to 30 days before you get an update. Don’t delay on resolving these issues, especially if you’re planning to apply for credit anytime soon.
Canceling a credit account is just one way your credit score is impacted. To learn more, watch our Credit 101 Webinar.