Often, when someone has clawed and dug their way out of debt, they destroy their credit cards and cancel their accounts. Many do this because they blame the credit cards and look at them as plague-carrying rats. In other words, they fail to acknowledge that the credit card is an inanimate object which has absolutely no power to make them do anything – instead, they use them as the scapegoat and have learned little from their experience except how much it stinks to be in debt.
Admittedly, there are those who destroy their cards and cancel their accounts because they absolutely HAVE TO remove any and all temptation to assure they never go back down that rabbit hole. They recognize they just don’t have the willpower, and you have to respect that.
Whatever motivates a person to want to take these extreme steps, canceling their credit cards is the absolutely worst thing they can do in the long run. To understand the impact of canceling a credit card on your credit score, you need to understand how that number is derived. There are five factors that go into calculating your credit score:
- Payment history
- Credit utilization
- Length of credit history
- New accounts
- Credit mix
Of these factors, your payment history carries the most weight in determining your score, followed by credit utilization and then the length of your credit history. New accounts and your credit mix (having a mix of loans, credit cards, mortgages etc.) carry the least weight.
Canceling a credit card, obviously, directly affects payment history, credit utilization, and length of credit history – in other words, canceling a credit card completely nullifies the first two and it puts an end to the last one.
Your credit utilization is a measure of your debt against your available credit and, ideally, it should be kept at 30% or less. If your utilization exceeds that threshold, your score could take a hit. Therefore, if you have a total line of credit worth $10,000, you should make it a point to never carry more than $3,000 in balances at once.
If the temptation to go on a shopping spree with a newly zeroed-out credit card is far too strong, let me make a suggestion: take a look at your monthly bills (utilities, insurance, cell phone, etc.) and choose the ones that don’t vary too wildly and total less than 30% of your available credit. Put those bills on autopay with your credit card and pay that ONE bill in full each month when it arrives; then take that card, fill a Ziploc bag with water, place your credit card inside the bag, and chuck it all into the freezer . . . but don’t cancel the account. If you feel the “need” to use that card, the time it will take to chisel away the ice or have it thaw SHOULD be enough of a deterrent. You think I’m kidding, don’t you? I’m not.
Keeping that credit card open, used, and paid off each month will do wonders for your credit score. Conversely, canceling that card will stall any efforts to improve your score. The old saying of “credit never sleeps” is true, and many have learned it means how debt and its interest are unrelenting, but with today’s article, we should take it to mean that it never stops HELPING us improve our credit scores if we control it.
When I was a young whippersnapper, I played a game with my fellow whippersnappers –both boys and girls –called Telephone Line. I’m sure most of you have played this game in one form or another, whether it was called “Telephone Line” or something else. You would sit in a circle –the more people the better –and one person would start the game by whispering a phrase like “my dog has fleas” into the ear of the person to her/his right (or left, depending on your political leanings). The person in whose ear the phrase is initially whispered turns to the next person in the circle and repeats that phrase in a whisper, and the game follows in that manner until the phrase has been passed to the last person in the circle. At that point, the final person in the circle repeats out loud the phrase as she/he understood it.
Ninety-nine times out of one hundred, the original phrase changes rather dramatically through repeated retellings usually due to poor hearing, muffed whispers, possible regional accents, and the kid who’s chewing a wad of bubble gum while passing the phrase along to her/his circle mate. And when it gets to the end, “my dog has fleas” has become “the designated hitter rule has ruined the game of baseball” (or something along those lines). Sure, it’s possible that you have one smart aleck kid in the middle of the line who purposefully changes the phrase (I don’t know anyone who would do that), but this usually happens because humans are involved –and humans, the well-intentioned beasts that we are, just don’t have a corner on the market of perfection. That’s how myths and misconceptions come into existence –and the mortgage world is certainly not immune to them. Let me address just two myths concerning credit scores.
Myth #1: having your credit report pulled by a lender will hurt your credit score. That’s a bold-faced lie! Honestly, it’s PARTIALLY true, but it’s not NEARLY as adverse in its effects as so many rampantly believe. The true part is simple: when you have a lender pull your credit report, this signals that you’re considering as assumption of debt, so the credit scoring trolls who live under a bridge (in a van down by the river) note that you’re displaying “risky” behavior. However, the REAL TRUTH is that such a pull doesn’t knock your score down into basement –and along those same lines, if you have your credit pulled by multiple lenders in a short period of time because you’re shopping for the best mortgage provider, those pulls will only be viewed as one action.
Myth #2: closing out credit cards will improve your score. Paying them off, yes, will improve your score, but closing them can actually HURT your credit score. In general, credit scoring models don’t measure risk by how much credit you have availablebutrather by how much of that credit you’re using – a ratio known as “credit utilization”. When you close an unused account, you reduce your total available credit, so your credit utilization goes up. The trolls don’t like things that go up.
The moral here, of course, is don’t believe everything you hear/read (except this column because this is the absolute truth, of course). Ask questions and investigate so you can be better informed –but be careful who you ask because it might be that kid with the giant wad of gum in his mouth all grown up, and you won’t understand a word he says.