In communicating the message that credit matters, we have scared some people about making moves that are actually in their best interest.
Many people are too far in debt, and that has to change. That’s why I began this year with a challenge. I want people to declutter their homes and their finances. So I’ve encouraged people to participate in the 21-day #NoDebtNoMess Color of Money Challenge.
Last week, I discussed clearing away credit card debt and eventually closing cards you don’t need or want. The suggestion had a few readers and some credit-counseling experts alarmed. I have a feature called “Talk Back,” in which I allow people who disagree with me to have their say. Here is some of the feedback I received.
A credit counselor wrote: “Canceling all the cards you don’t use at once may affect your credit utilization ratio. This could hurt your credit score.”
Worried about just that, one reader, with an outstanding score of 800, wrote, “I took an unused card to the bank with the intention of closing it but was informed that closing the card, even though it had no balance and had not been used for quite some time, would lower my credit score. Is the bank employee correct?”
I understand people’s concerns about closing accounts. The way you handle your credit can affect loan and insurance rates. A poor credit history might lose you an apartment.
But here’s my concern: People hear that it’s vital to have “good” credit and they think that means they need to carry debt.
If you’ve established a history of responsible credit management by, among other things, paying your bills on time and keeping credit card balances low or paying them off every billing cycle, you’ll likely see minimal impact to your score by closing an account, according to experts from Equifax, Experian, TransUnion and FICO, the company that created the credit-scoring model used by most lenders.
As part of my discussion on getting rid of credit card clutter, I recommended that you not cancel any card if you’re carrying a balance on it or any other of your cards. I said that, ultimately, you could close accounts you don’t want once all the cards had been paid off.
Ideally, if you have debt and you won’t be tempted, just put the cards away and work on paying off the debt. If you close an account and you still have debt on that card, it can increase your utilization rate, which is an important measure of how much credit you are using at any one time.
But if you know that having an open card is too much temptation, cancel it. Then commit to a plan to pay it off. Your utilization rate will improve as you pay down your debt.
And contrary to what that bank employee told my reader, if you close an account that you’ve had for some time, its long history does not immediately disappear. Positive credit history can stay on your credit report for 10 years from the date the account was closed. It’s important to realize that after your credit score reaches a high enough level, minor changes won’t have a significant or long-term affect on your credit history.
Let’s look at the FICO model. A score can range from 300 to 850. If a lender is giving its best rates to creditworthy customers with scores of 750 or higher, it doesn’t matter what your score is if you are above that point.
Your score is constantly changing. It dips and rises based on a number of factors, including what you do in any given period as companies update your credit files with new information.
Let’s say you have a credit card with a limit of $1,000. In one month, you charge about $800 worth of merchandise. But because you pay off your balance, you think, “No problem.”
If you pull your score before the next information dump, however, before your payment — in full — has been applied to your card, you might see a slight drop in your score. Or you might not.
No matter what credit tier you are in, you want to be aware of any moves that might lower your score. But you need to look at the big picture, not just your credit score.
If you find yourself in a credit mess, don’t be afraid to clear the clutter.