Closing credit accounts may make sense if you struggle with spending discipline, but closing an account that supports your credit history and debt utilization ratio can have a negative impact on your credit score. Consider the pros and cons of closing the account relative to your own financial habits before closing an account.
Credit Score Basics
Your FICO credit score is based on the Fair Isaac Corp. scoring model that serves as the basis for modified rating systems used by three major credit reporting bureaus -- Equifax, Experian and TransUnion. Each company issues a credit score based on your credit history and related scoring factors. Lenders then use your score when making decisions on new loan applications and establishment of rates and terms.
Credit History
The FICO scoring model uses a number of specific items, but they generally fall into five categories, according to the MyFICO website. Payment history and length of credit history combine for about 50 percent of your total score. If you have a strong history of on-time payments and a length credit history with a particular creditor or card account, closing that account removes that history from your score. It also prevents a potential lender from seeing that account history on your score report. Too many new accounts and fewer long-term accounts can also negatively impact your score.
Debt Utilization
An additional 30 percent of your FICO score calculation is derived from factors that MyFICO labels "amounts owed." This category compares your debt usage to available debt. Lenders want to know how much of your available debt is currently in use. If you have $20,000 in available credit and $5,000 is in use, your debt utilization ratio is 25 percent. A low debt utilization generally shows that you are not overwhelmed by current debt when you make a new loan application.
Your Decision
Again, you need to compare the credit score implications against your spending habits and goals when considering closing an account. If you have a credit card account with only six months of history, a low limit and limited use, the affect on your credit score is minimal. If you have a five-year history on a card with a high limit and significant usage over time, you might consult with your financial adviser before closing the account.
0 comments:
Post a Comment