Closing a credit card can hurt your credit score in a number of ways. It impacts your payment history and length of credit variables, which account for half of your FICO score, according to the website MyFICO. It also negatively affects your credit utilization ratio, which accounts for another 30 percent of your score.
FICO Importance
FICO, developed by the Fair Isaac Corporation, is the scoring model used as the basis of credit scoring computations from Equifax, Experian and TransUnion, the three major credit reporting bureaus. Lenders rely on one, two or all three reports when making loan decisions and setting loan rates and terms. MyFICO pointed out in a July 2006 mortgage loan rate table that a credit score from 720 to the maximum 850 typically netted a 30-year fixed loan rate of 6.78 percent. A score from 500 to 559 meant a rate of 9.29 percent. This could mean a difference of tens to hundreds of thousands of dollars difference in interest costs over the life of a mortgage.
Credit Utilization
Every time you use a credit account, open a new account or close an existing account, you impact the "amounts owed" category of your FICO score. This measures your percentage of available credit currently in use. It is important to lenders because they want to know if you are already debt-strapped when you apply for a loan. By cancelling a card, you remove that amount of available credit with no effect on your usage. This eliminates a zero percent utilization on that card and removes the card limit from your overall utilization calculation. This negatively impacts your score, with point value dependent on the actual limit.
History
When you cancel a card, your history of use stays with your credit report for seven years, according to The Motley Fool's Dayana Yochim. Thus, you get no benefit from cancelling a card to negate late payments and other negative marks against it. Perhaps worse, when you cancel a card with a long running history of responsible use, you eventually lose those benefits in the category that makes up 50 percent of your score. The longer your history with the card, the worse the impact.
Why People Cancel
People often cancel credit cards to consolidate debt, to avoid overspending or to avoid annual maintenance fees on unused cards. However, you need to consider the implications on your credit score when doing so. Even saving a few dollars on inactive fees provides little benefit compared to the potential of losing a fraction of a percentage point or more on major loans for homes and autos.
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