One of the simplest things you can do to maintain a healthy credit score is to use your credit cards occasionally, even if you don’t really see a need to. I can’t tell you how often I’ve heard people say things like “I don’t use this credit card a lot, I should just close it” or “I forgot I even had that card until the company sent me a letter saying they were going to close it!” and this is a bad way to approach credit.
Aside from people thinking that it may be good to close their account, the credit card company themselves may opt to close your account on their own. In some cases, such as the credit card being phased out, there may not be a lot that you can do. Sometimes companies give you a warning, stating that if you do not use your card in the next few months then they will close it. The worst, though, is when companies decide to close your credit card with no warning. Each credit card company is different, but generally speaking you will be on steady ground if you make at least one purchase per year.
Let me discuss why having a credit card account closed, regardless of how or why it is done, is a usually a bad idea.
In a previous post I described the various factors that determine how good or bad your credit score is. In this post I’ll be focusing on the impacts of open versus closed accounts only with respect to credit cards. Although other accounts, such as loans, appear on your credit report, there’s not a lot you can do with respect to them and how they impact your credit report other than pay them on time and, eventually, pay them off entirely. Having a loan account closed because you paid it off is generally a good thing!
What does having an open but rarely used credit card account do for you? First, because that credit card has some line of credit associated with it, it ultimately helps you with your utilization. Suppose you have two credit cards, one which you use often and have a balance of $1,000 out of the $5,000 limit, and the rarely used card with a balance of $0 but a credit limit of $5,000. If you were to close the rarely used card, your utilization would jump from 10% to 20%!
Another big reason to keep a rarely used account open is that it will usually help your credit age. This is, in part, due to the fact that closed accounts stay on your report for several years (typically ten years if it had a good payment history, seven if the payment history was bad) and continue to age. Suppose that you have two cards with five year histories and all on-time payments. You close one and then, ten years later, you open a new card. Your credit age will be ( 15 + 0 ) / 2 = 7.5 years. If you had kept both cards open, your credit age would be ( 15 + 15 + 0 ) / 3 = 10 years.
As mentioned above, closed accounts remain on your credit report, but once it drops off then the total number of accounts that you have will go down by one, which is a negative. Having that account open will also increase your good payment history, another factor in your credit score.
When the account is closed, a note is placed indicating why it was closed. If it was closed at your request that is a different note than if the creditor closed it. Although this doesn’t impact your credit score, with important events where your credit report is scrutinized closely, such as applying for a home loan, notations that the creditor closed the account may reflect poorly on you and negatively impact your ability to secure the loan or get the best rate.
Finally, do note that the impact of a closed account may be felt by some more than others. Closing one account when you only have two accounts will result in a bigger impact than closing one account when you have more than a dozen.
Now you know why you probably shouldn’t choose to close your accounts, but what should you do if the credit card company decides to close your card for any reason? Also what if you want to close a credit card due to having an annual fee? I’ll cover these scenarios in my next post, but I’ll note now that handling these situations intelligently can result in being able to keep your card, avoid annual fees, and even negate the impact to your credit score.
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closing credit cards: I agree with the credit utilization statement ( although you could just ask the first company to increase your credit limit), but I don’t agree that number of open accounts or credit card age is a good enough reason. Credit card age doesn’t affect your credit score very much. Use any of the credit simulators out there ( chase, credit karma, etc) and change the average age of your accounts. One year or 5 years doesn’t make much difference. Maybe 5 points or so. Number of total accounts you have had lifetime is actually a ‘more is better’ factor. And I haven’t seen anything that shows a large number of closed accounts is a bad thing. I try and keep the number of open credit cards I have to under 10 just so it is manageable, not because closing accounts is bad. Now, having too many new credit requests in a short period of time can hurt you. Not your credit score but your chance of obtaining a new account. Credit card companies now look at more than just FICO score.
To Jimmy Jazz: Just to note, the version of this article that was initially posted was an older draft and has been replaced. Hopefully it’s still relevant with respect to what you wrote.
I don’t think we disagree. The things discussed here are minor with respect to credit score, but perhaps more important in the context of myths about credit that people believe or things they have been told by others.
A lot of closed accounts can be bad, especially if you didn’t close them. As you accurately state, companies quite frequently look at more than the credit score. Obviously if an account is closed because due to lack of payment then you may have bigger issues with your report, such as a collection agency, but even when accounts are closed due to disuse this raise flags when you apply for other lines of credit.