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December 15, 2006
Canceling your credit cards can hurt you
The exact calculation to determine your FICO score, that all-important number that supposedly measures your credit worthiness, is a mystery. That's because the company that derives your FICO score, the Fair Isaac Corporation, wants it that way so that no one can copy it exactly.
However, even though we don't know the specifics, we know enough about how the score is calculated in general to say that canceling you credit cards can actually hurt you credit score.
The reason? When you cancel a card, your "credit-utilization ratio" changes. For example, let's say you have two credit cards, where one is your favorite card that has a $2,500 balance and a $5,000 limit, and the other one (the one that you never use and are thinking about canceling) has a $0 balance and also a $5000 limit. So your credit-utilization ratio, your total balance divided by your total limit, is 25% ($2,500/$10,000 x 100%).
If you cancel that card, this ratio jumps to 50% ($2,500/$5,000 x 100%). Since this ratio affects about 30% of your total FICO score, that could lower your score by quite a bit.
Another 15% of your FICO score is affected by credit history. So again, let's say you just have two cards, the one you like to use but you've only had a year, and the one you're thinking about canceling but you've had for five years. By canceling that card, the average age of your credit cards drops from three years to one years, which in this case would lower your FICO score.
Finally, if you don't use your card for a while, the credit card company may offer you an incentive to use it again. For example, Discover Card offered me $20 to start using my Discover card again.
Posted by brian at December 15, 2006 01:45 PM
Comments
I'm sure you have done more research than me on this issue, and all the points you have are valid - however, there is such a thing as having too much credit - take me for example. when i applied for my mortgage, the lenders highly recommended i close a few of my higher limit cards, as banks will frown upon an individual taking out a $150K+ mortgage that also has ~$60K in available revolving credit (all being determined by your income i must add!) - as this was from my own personal experience
Posted by: zarraza at January 16, 2007 12:01 PM