If you are in the process of paying off credit cards, congratulations, you’ve taken a great first step in reclaiming your financial future. A few years ago I found myself deep in debt, and over the course of a couple years, I worked like a mad man to get all of my credit card balances down to zero. I was ready to part ways with credit cards altogether, but I was left with a question. Does closing a credit card hurt your FICO score?
It is an important question, and the answer depends on a couple different factors.
Credit Utilization Ratio
In general, yes, closing a credit card can have a negative affect on your credit score. This is largely due to the reduction of your available credit, which causes an increase in your credit utilization ratio.
That is, the amount of outstanding debt to total credit available. Most credit scoring agencies suggest keeping this amount at less than 30% for optimal results. That means if you have one credit card with a $10,000 balance, it’s a good idea to keep the balance at less than $3,000. Anything higher is considered a heavy debt load, and subtracts from your score.
Length of Credit History
Another factor to consider when closing your credit card after it reaches a zero balance is the affect on your average length of credit. Imagine you have three credit cards. You obtained the first one 10 years ago, the second 5 years ago, and the third credit card just a few months ago. Closing that ten year-old account would have a significant impact on the average time your active accounts have been open.
A long credit history equals a higher FICO score, assuming there are no other blemishes. If you are determined to live with only one or two cards, considering closing the newer accounts first.
Credit Inquiries Can Reduce Your Score
If you close all of your credit cards, but decide later down the road you need to have one, too many credit inquires can negatively affect your credit score. It might be a good idea to just stash your best credit card in a sock drawer and forget about it until the need arises, rather than cutting it up and having to reapply months later.
Of course, all of this advice assumes you have made a financial turnaround and no longer spend more than you earn. Credit cards make this habit particularly easy, so be careful about going right back into debt by relying too heavily upon the cards.
If you find this happening, I strongly suggest moving to 100% cash until you feel you are ready. Yes, credit cards are convenient, but they are not without risk. Declaring a cash budget and sticking to it for a few months may help exercise your frugality until you are ready to give swiping another try.
Image by Morgan on Flickr