credit cards

Why closing an account hurts score

Leslie McFaddenq_v2.gifDear Credit Card Adviser,
In your Jan. 15 article, you indicated a person could lose 50 points on their credit score because of an account being closed. That very same thing has happened to me due to WaMu's discontinuation of the secured credit card program they had. I have worked very hard on my credit during the past several years, and to see it go down this much through no action of my own hurts pretty bad. Could you please explain why this happens?
-- Sam Secured

a_v2.gifDear Sam,
You're not alone. In this environment, many people face canceling their credit cards to opt out of negative account changes, or as in your case, are seeing their accounts closed by their issuer.

An account closure will never help your score, but how much impact it makes depends on what is in your credit report. Barry Paperno, the consumer operations manager at Fair Isaac, the company that created the FICO score, walked me through the effect that account closures can have on the five factors that comprise your FICO score.

Elements of your credit score

Biggest impact: amounts owed. The biggest and most immediate impact on your score is the toll on your credit card utilization, or the ratio of balances to credit limits. About 30 percent of your score depends on that calculation.

If you shutter an account with a zero balance, that credit limit won't get factored into the utilization calculation. Closing accounts should have less impact if you have other high-limit accounts that are open and in good standing.

Let's say you have two credit cards: one with a $5,000 credit limit and one with a $10,000 credit limit. You owe $3,000 on the $5,000-limit card and nothing on the other card. Your overall utilization is about 20 percent. If the card with the higher limit gets closed, your utilization would jump to 60 percent. The utilization spike could cause a dip in your score.

If you have a balance on the account when it's closed, the score will include the limit and balance on the closed account in the utilization calculation. As you pay down the balance your score might improve until the balance gets to zero. "In terms of the impact to your score, you could actually lower your score once the paid-off, closed account hits zero," says Fair Isaac's Paperno. That's because once it's paid off, the credit limit no longer gets factored into the utilization ratio.

Secondary impact: length of history and mix of credit. Canceling cards doesn't impact the factor that looks at payment history. As long as closed accounts remain on the credit report, they will get included in your payment history. Once paid off, an account with no delinquencies will disappear from the credit report within 10 years. Accounts with late payments can remain for seven years. When the account falls off the credit report, the score could take another hit, albeit as late as 10 years after closure.

The loss of the account can affect two factors: the length of credit history and mix of credit, which make up 15 and 10 percent of the score, respectively. Closure of the oldest account would affect the score more than shutting down a newer tradeline. Note: the factor that considers types of credit used includes both open and closed accounts.

The silver lining to dealing with the ding to your score is that paying down balances on your other accounts can revive your score again.

Use our FICO score estimator to gauge your credit score for free.

Ask the adviser

To ask a question of the Credit Card Adviser, go to the "Ask the Experts" page and select "Credit Cards." Read more columns by the Credit Card Adviser. Follow Leslie McFadden on Twitter.

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