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Everyone knows that your credit score is important to your financial life, affecting the rates you get for mortgages, credit cards and insurance. Improving your score may save you thousands of dollars in interest. So would it help your score if you got rid of a credit card?
"Pay your bills on time and keep your credit expenditures
under control, and you won't have to worry about your credit rating,"
says Craig Watts, spokesman for Fair Isaac Corp., which calculates
the FICO score for consumers. "If you're having trouble doing
that, sometimes canceling a credit card in an effort to get your
credit behavior under control is more important than your credit
score."
That's the short answer. But since virtually everything
that makes up your credit score depends on something else -- depends
on your credit mix, the number of cards you carry, the length of
your credit history, your rate of credit utilization and myriad
other things -- there is a longer answer.
In most cases, canceling a credit card won't help
your credit score. In fact, it may actually hurt your score. You
see, your credit score depends on how you shake out in five different
credit-scoring categories, each weighted differently when calculating
that score.
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| What counts in a credit score? |
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| This chart shows how Fair Isaac
Corp. values the various parts of your credit
management to determine your credit score.
Source: Fair Isaac Corp. |
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According to Evan Hendricks, author of the book "Credit
Scores and Credit Reports," canceling a credit card potentially
can hurt you in at least two of the five categories -- and maybe
even a third.
Credit-utilization ratio is
key
First, canceling a card could upset your credit-utilization ratio,
the second most heavily weighted category in Fair Isaac's credit
scoring algorithms. For example, assume you have three cards with
total available credit of $20,000. Assume further that your outstanding
balances total no more than $6,000 of that available credit at any
one time. Since creditors like to see a credit-utilization ratio
of 30 percent to 35 percent or less, you're in good shape. Now,
assume that you cancel a card with a zero balance and a $10,000
credit limit. Suddenly, your utilization ratio jumps to 60 percent,
and your credit score drops.
As counterintuitive as that seems, that could happen.
Impersonal credit-scoring systems aren't concerned so much with
how much available credit you have but with how you manage that
credit. And in the credit-scoring world, a 30 percent utilization
rate is much better than a 60 percent one. "That's what scoring
models want to see, a good utilization rate," Hendricks says.
Furthermore, he says, canceling that card could result
in a double whammy to your credit score, "because each card is scored
individually, and then all your cards are scored together. (If)
you've just canceled the card with a zero balance, (you've) lost
a great individual score." Regardless, if you still want to cancel
a card, he says, "make sure to pay down your other balances to keep
that rate in line."
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