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Money Girl

147 MG Does Canceling a Credit Card Hurt Your Credit Score?

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Broadcast on:
02 Mar 2011
Audio Format:
other

Like what you hear? Help us out by writing a review at iTunes. Questions go to money@qdnow.com. Thank you!

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I'm your host, Laura Adams. The last two shows have been about credit cards. The right strategy for paying them off and how to use a balanced transfer card to your advantage. But what happens after you achieve the goal of paying off a card? In this show, I'll discuss whether you should close a credit card account or not. After you pay off a regular credit card or a balanced transfer card, the next logical question is what to do with it. Maybe you have another credit card or two, so canceling one seems like a good way to simplify your financial life. Or perhaps you really struggled to pay off a card that you used to freely in the past. Now you're determined to close it so you don't get lured into the trap of overspending again. Those are both very good reasons to cancel a credit card. But before you do it, you may be surprised to hear me say that there are actually some good reasons not to do it. Cancelling a credit card can hurt your credit score. To understand how that's possible, I need to explain a bit about how your credit score is calculated. There are different credit scoring models that exist, but you've probably heard of the one used by most lenders, the FICO score. FICO stands for the Fair Isaac Corporation, and you can find more information about it at MyFICO.com. According to MyFICO.com, the factor that influences your credit score the most is your payment history. Whether you've been naughty or nice to your creditors makes up 35% of your score, so remember to pay all your bills on time. The second most important variable is the number of accounts you have and how much you owe on them. That makes up 30% of your score. The third most important factor is the length of your credit history, having long-standing credit accounts as important and can make up as much as 15% of your score. The fourth factor is the number of recently opened accounts and recent credit inquiries. Having too many inquiries can jeopardize up to 10% of your score. And the fifth factor is the final 10%. It's the number and types of accounts that you have, such as credit cards, auto loans, mortgages, home equity lines of credit, and retail accounts, for example. Having a mix of credit positively affects your score. So let's discuss how the simple act of canceling a credit card can reduce your credit score. You'd think that canceling a credit card would be one less account on your record, right? Well, the problem is that a card cancellation negatively affects three of the five credit factors that I mentioned. The biggest issue is something called credit utilization. Credit utilization comes into play with the second factor, the number of credit accounts you have and how much you owe on them. Your credit utilization is expressed as a ratio of your credit balances to your available credit limits. It's also called a debt to credit ratio. 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As kids practice, they get positive feedback, awards and explanations for wrong answers. Ixcel figures out what your kids need more help with and recommends more topics to practice. Their videos, lessons, sample problems and learning games too. One subscription to Ixcel gets you all subjects and all grade levels. Membership started just $9.95 a month. It's no wonder Ixcel is used in 95 of the top 100 school districts. I think the positive feedback that Ixcel gives is really crucial when it comes to learning. So make an impact on your child's learning. Get Ixcel now and money girl listeners can get an exclusive 20% off Ixcel membership when they sign up today at Ixcel.com/moneygirl. Visit Ixcel.com/moneygirl to get the most effective learning program out there at the best price. With Wi-Fi that reaches the attic, I finally have a home office. Get a free upgrade to T-Mobile Home Internet Plus while supplies last. Home Internet Plus starts at $50 a month with auto pay in any voice line. Check availability at T-Mobile.com/home-internet. During congestion customers on this blind mean notice speeds lower than other customers and further reductions using greater than 1.2 terabytes per month due to data prioritization. After $20 bill credit plus $5 per month without auto pay, debit bank account required regulatory is included for qualifying accounts. $35 connection charge applies. Let me give you an example. If you have a credit card with a $4,000 credit limit and your balance is $1,000 you're using 25% of your available credit. To calculate your credit utilization for any credit account simply divide your current balance by the credit limit. For my example the calculation is $1,000 divided by $4,000 which equals 0.25 or 25%. There's no specific ratio that FICO or the credit bureaus recommend but the lower you keep your credit utilization ratio the better. Many experts propose that you use 30% or less of your available credit to optimize your credit score. Anytime your available credit limit is reduced it increases your utilization ratio which can negatively affect your credit score. So canceling a card even one that's paid off leaves you with less available credit. That increases your utilization ratio and causes your credit score to drop. An important quick and dirty tip is to never max out all your available credit lines even if you pay off your balance in full each month. It's better to have two credit cards that each have balances below 30% of your credit limits than to have one card that you consistently max out. Keeping a good cushion of available credit can raise your credit score. Another issue to consider before you cancel a credit card is how long you've had it. Your credit history is the third most important factor in the calculation of your credit score. Canceling a long-standing credit card shortens your history which could be an additional injury to your credit score. The last reason I'll give you not to cancel a credit card is that you need a healthy mix of credit accounts. As I mentioned that makes up 10% of your credit score. If you cancel your only credit card that would leave you deficient in the revolving credit category. It's important that you weigh the pros and cons of canceling a credit card for yourself. I certainly discourage you from having a credit card if you wouldn't use it wisely. If you can tuck it away and use it only for emergencies that's great. But if the temptation to use it would still be there one solution is to keep the account open for the sake of your credit score but to shred the card. On the money girl section at quickanddirtytips.com you'll find show transcripts, my contact information and links to connect with me on Facebook and Twitter. There's also a link to my audiobooks and code for a great money girl widget that you can put on your own blogger website. Are you making travel plans for this fall? Be sure to listen to quick and dirty tips to get more for less from the deal list up. Show number eight will give you money saving strategies for traveling through the holiday season. I'm glad you're listening. That's all for now. Courtesy of money girl. Your guide to our richer life. Earning your degree online doesn't mean you have to go about it alone. At Capella University we're here to support you when you're ready. From enrollment counselors who get to know you and your goals to academic coaches who can help you form a plan to stay on track we care about your success and are dedicated to helping you pursue your goals. Going back to school is a big step but having support at every step of your academic journey can make a big difference. Imagine your future differently at Capella.edu. 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