Americans have an average of four credit cards. Do you need that many? How many is enough?
Too often we hang on to credit cards we no longer use. This provides an invitation to identity thieves to run up charges in your name. Canceling unused credit accounts is a good idea, if done properly.
Christians should always take Proverbs 10:4 seriously. It reads, “A slack hand causes poverty, but the hand of the diligent makes rich.” We certainly don’t want to have a slack hand” when managing credit cards.
Here at FaithFi, we get a lot of questions about credit cards and two of them go something like this: “If I close a credit card account, will it affect my score?” And, why will it affect my score?”
Your credit score will drop a little after closing an account. Most people are surprised by that because it seems like they’re being punished for doing the right thing. Actually, it comes down to mathematics and complicated computer algorithms, which are just sets of rules that solve problems in a limited number of steps.
Algorithms live in computer models that give you more credit score points for having three things:
If closing an account falls affects one or more of those factors, your score will drop temporarily. Put another way, the longer you have an account open, the more credit you don’t use, and the more types of accounts you have, the higher your score. Those three factors make up 55% of your FICO score.
Why is that? It’s simply because having old accounts, unused credit and more kinds of accounts are signals to lenders that you’re more likely to pay them back.
Is a slight drop in your credit score really something to worry about when you close an account? Usually not, but there’s one occasion when it could be important.
If you’re shopping for a mortgage or some other kind of loan, you want the highest credit score possible. Lowering it by even a few points could put you in a lower range of scores and that could affect the interest rate you’re offered. A higher interest rate means more money out of your pocket every month.
In most cases, however, when you’re not seeking a loan, a slight drop in your credit score means very little. You’ll quickly make that up if you keep the outstanding balances below 30% of available credit on your remaining accounts and you make your payments on time.
Another question we sometimes get is, “Why bother closing an account after you’ve paid it off, especially if it’s going to cost you points on your credit score?” There are at least two good reasons.
Even though it’s a good idea to close unused accounts, it’s not a good idea to close several at once. That compounds the negative impact on your FICO score. Instead, close these accounts gradually, no more than one or two every six months. That minimizes and spreads out the negative impact.
Take these steps to close an account:
After you close an account that you no longer need, you can rest a little easier that identity thieves can’t use it against you. That’s a small price to pay for a temporary, minor dip in your credit score.
You can also listen to the related podcast on this topic.