Read the popular press, and it's easy to believe our credit scores must be constantly tweaked and monitored to keep us alive. It's a credit score, people, not an ICU patient.
This week’s reader question is one I’ve received many times, which raises the likelihood you’ve wondered about it as well. Here it is, in an edited version:
I got a bug to buy a house. Went to a mortgage broker, and one of her first pieces of advice was to land a secured credit card, which I did. Amazingly, I was able to purchase a home. I refinanced my card, things are looking good. I was even able to recently score a non-secured credit card with the same company where I have my secured card. My question is this: Should I cancel the secured card? It has an annual fee and no perks, whereas the new one has no fee and cash-back perks. I’ve read so often to not cancel cards as it adversely affects one’s credit, but it seems silly to have them both. Any advice? Thanks for your time and attention.
The short answer to your question, Elise, is yes, it’s fine to cancel your secured card. There’s no reason to pay a fee for a card you’re no longer using. Only exception? If you’re currently in the hunt for a mortgage or other loan. In that case, it’s best not to cancel existing lines of credit.
Now let’s take a look at the logic behind that answer.
There’s a reason Elise has read that canceling cards can have a negative effect on your credit score. It can. Here’s how:
Higher credit utilization ratio = lower credit score
“Credit utilization ratio” is a $2 term for a 50 cent concept. It just means the amount of credit you’re using compared to how much you have available. For example, if you’ve got a credit card with a $10,000 limit, and your balance is currently $3,000, you’re using 30 percent of your available credit, and your credit utilization ratio is also 30 percent.
The most widely used credit score, the FICO score, penalizes those who use too much of their available credit. Which makes sense. Nobody wants to lend money to someone up to their eyeballs in debt. So keeping your credit utilization ratio low by not using all your available credit is a good idea.
Many financial types will point to 30 percent as the magic number for credit utilization, suggesting you never use more than 30 percent of your available credit. Keep in mind this doesn’t refer only to the closing balance on your monthly statement. Since your credit score can be pulled anytime, the advice would be to never stray above 30 percent. Doing so, they insist, will destroy your credit score.
How credit utilization works
Credit utilization ratios can be computed by credit line or in total. Say you have two cards, each with a $5,000 credit limit. One card has a $2,000 balance, and the other has a zero balance. Computed individually, the card with the $2,000 balance has a 40 percent utilization ratio, and the one with a zero balance has a zero ratio.
Computed in total, you have $10,000 of credit available and $2,000 outstanding, so your overall credit utilization ratio is 20 percent.
Many experts would suggest that, to maximize your credit score, you should shift $1,000 from one card to the other. Then you’d still have an overall ratio of 20 percent, and each card would also have a 20 percent ratio.
Note that by canceling your unused card, your total available credit is $5,000, and you’re using $2,000, giving you a 40 percent ratio, both on that card and in total. This is why many experts recommend keeping accounts open, even if you’re not using them.
Your credit score is based partly on the length of your credit history
Another reason not to close accounts: A longer history is better than a shorter one, so older accounts are better than new ones. This is also logical. After all, you’d rather lend money to someone with decades of experience paying it back on time than to someone who’s only been dealing with credit for a few months. Therefore, the experts will tell you, closing older accounts will lower your credit score.
It doesn’t hurt to leave old credit lines open, as long as you don’t have too many, are not being charged an annual fee and won’t be tempted to overspend. So unless there’s a reason to close an account — like an annual fee — just stop using it. If you’re ever notified that your account will be closed for inactivity, and it’s one you want to keep, make a small purchase, pay it off, then place the card back in plastic purgatory.
Now that you’ve learned all this, ignore it
In light of what we’ve just learned, why am I advising Elise to get rid of an unused card that carries a fee? Because, in my opinion, most so-called experts are putting far too fine a point on this stuff.