It's easy enough to apply for a credit card today only to forget about it over the next year or so. However, that account still remains open and active on your credit report. Consequently, this can have an affect on your overall credit rating since having too many credit lines open could make you look like a worse credit risk in the eyes of lenders. They might be wary that you'll be overextending yourself.
In addition, if you have several accounts open, there's a greater chance that you will forget about an account you opened awhile back and you could unintentionally stop making payments on it. Therefore, it might be a good idea to maintain open accounts for some of your accounts, even if you plan on paying them off. In fact, you should keep at least 2 or 3 accounts open regardless of how much you use them because otherwise, there won't be anything for lenders to use to determine your credit history on. In this case, accounts are not just limited to credit cards, but can also include personal loans, mortgages, student loans, etc.
How Closing an Account Can Affect Your Credit Report
It's also important to understand that once you close an account, the record of the closed account remains on your credit report and can affect your credit score for a while. In fact, closing unused credit accounts may actually cause your credit score to drop in the short term, as you will have higher account balances compared to a smaller available credit.
For example, let's say you have four accounts, each with available credit lines of $1000 (so $4000 in available credit). And let's say you owe $500 on two of the cards and the other two are cards you want to close (so you owe $1000 total and have $4000 in available credit). Well, since lenders factor in how much you owe vs. how much credit you have available, if you close those two cards, you go from owing 25% of your available credit ($1000 out of a possible $4000 available credit) to owing 50% of your available credit ($1000 out of only $2000 available credit). This might actually cause your credit score to drop, at least in the short term. In the long term, though, not having extra temptation to charge and not having credit you don't need is much more of a benefit.
The Importance of Monitoring Your Credit Report
It's a good idea to monitor your credit report from time to time, especially if you're making significant changes like applying for new credit or closing older accounts. That way, as you gradually pay off your debts and streamline the number of accounts you have, you'll also be aware of any potential negative impact your actions might be making, either short term or long term. You'll also be able to watch your score increase over time and there's nothing like positive feedback to keep you on track with your goals.
By following these tips, you can avoid some of the common pitfalls consumers face when paying off their credit accounts. Now that you are aware of these concepts, you can ensure that you're making the best decisions in terms of your credit and put yourself on the fast track to being debt free.
Of course, if you think about it, what's kept you from racking up big balances before now? If you've been pretty responsible with credit in the past, you're likely to continue to be pretty responsible in the future. That's the basic principle behind credit scoring: It rewards behaviors that show moderate, responsible use of credit over time, because those habits are likely to continue.
The score also punishes behavior that's not so responsible, such as applying for a bunch of credit you don't need. Many people with high credit scores find that one of the few marks against them is the number of credit accounts listed on their reports. When they go to get their credit scores, they're told that one of the reasons their score isn't even higher is that they have "too many open accounts." Many erroneously assume they can "fix" this problem by closing accounts.
But after you've opened the accounts, you've done the damage. You can't undo it by closing the account. You can, however, make matters worse. Closing accounts can hurt you in two ways:
1. Closing accounts can make your credit history look younger than it is. Your credit score factors in the age of your oldest account and the average age of all your accounts. So closing accounts, particularly older accounts, can ding your score.
2. Closing accounts reduces the credit available to you, making your debt utilization ratio soar. The "FICO" formula measures the gap between the credit you use and your total credit limits. The wider the gap, the better. If you suddenly lower that limit by shutting down accounts, the gap narrows - and that's a bad thing.
This is true whether or not you keep a balance on your credit cards or pay them off in full every month. Remember: The FICO formula doesn't differentiate between balances that are carried and those that are paid off. In reality, closing revolving credit accounts can never help your score, and it might hurt it.
There are, however, some good reasons to close accounts. If you have a serious spending problem, you might find cutting up and canceling your credit cards is the only way to keep yourself in line. If that's true, your credit score is probably the least of your worries.
Both Kevin Nelson & John Hilaire are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
Kevin Nelson has sinced written about articles on various topics from Information Technology, Fitness and Acne Treatment. Why are some people able to repair their credit quicklywhile others continue to struggle? Find Out Here: