The Impact Of Closing Credit Cards on Credit Scores
During the cold war, foreign policy experts in the west spent an amazing amount of effort trying to figure out what the Kremlin was doing behind closed doors. In fact, they even coined the term Kremlinology to refer to the study of an opaque process. In the post-cold war era, consumers still participate in a similar pursuit as we try to decipher the mysteries of the FICO score. And there are few subjects as misunderstood as the effect on our credit scores when we close a credit card.
What We Know About FICO
FICO is the Fair Isaac Credit Corporation, and it is their undisclosed formula that has become the Kremlin of credit. And like the Politburo of old, they are willing to release a general framework that describes their process. For example, 35% of their scoring formula is determined by a person’s credit history and 30% by the amount owed. 15% is based on the length of credit history while 10% each is based on the types of credit used and new credit.
When a cardholder closes and account, only two of these factors are affected. First, there is the amount owed. Part of closing an account is reducing the cardholder’s available credit. For a given amount of debt, reducing a cardholder’s available credit will decrease the cardholder’s debt to credit ratio. Fortunately, this makes up only a portion of the 30% that is attributed to the consumer’s “amount owed” component of his or her credit score.
The other part of a credit score that is affected when an account is closed is the length of credit history. This component can be affected the most when a cardholder closes the credit card that they have held the longest. It is for this reason that many credit card users try to keep their oldest accounts active, especially those that have no annual fee.
Ultimately, most students of credit scoring realize that in the absence of other negative information, it is no big deal to close an account. While some personal finance experts will debate the potential downsides of account closures, there is general agreement that these effects are minor and temporary. In contrast, everyone agrees that cardholders should devote their attention to paying all of their bills on time each month and keeping their debt levels low.
Unlike Kremlinology, the fate of the free world does not hang in the balance when a cardholder choses to close one of their accounts. But by understanding how the FICO score is affected by a closed account, cardholders can make the best decisions regarding their portfolio of credit cards.