How Closing Your Credit Cards Can Hurt Your Credit

Millions of Americans took on more credit card debt than they could probably handle in the wake of the recession when money became tight but their expenses kept piling up. Now, many may have considerable balances spread across a number of accounts and are looking for ways to pay them down and close out the cards. However, it's that last part that might actually end up doing a little more harm than they reckoned for.

When trying to improve financial standing and credit scores, clearing out massive credit card debts over several months of large repayments into those balances is one of the absolute best ways to achieve both ends, but if you're going through this process, you might find yourself at a crossroads when you finally bring your balance on one card all the way down to zero. Do you close it to avoid the temptation of racking up more debt on it later on, or do you simply let it stay open?

Why you shouldn't close it
The idea of leaving the card open may seem counterintuitive when you're trying to get a better handle on your debt. After all, if you leave an account open, it could lead you to start using that card again even if you don't currently want to, because you never know what the future holds. However, doing so can also keep your credit score, which you've just worked so hard to rebuild, as high as possible. The reason for this is relatively simple: The amount of debt you're carrying at any one time when it's compared to the total amount of your limits being used at any one time makes up 30 percent of your score.

This factor is known as "credit utilization ratio," and is very important to keep in mind when you're trying to rebuild credit scores that may have been damaged by questionable borrowing activity, no matter how necessary it was at the time. In general, lenders like to only see consumers carrying about 30 percent of their limits at one time, and any more than that will start to make a credit rating erode. So say, for example, that you have five credit cards with a combined credit limit of $20,000. If you're carrying any more than $6,000 in credit card debt at any one time, your score will not be as high as it possibly could be.

So why is that a problem when you've cut your debt to zero? Suppose that you owed a total of $7,000 on those five cards, giving you a utilization ratio of 35 percent, but you were able to successfully eliminate all the debt on one account and you want to close it down to avoid further temptation. If you just paid off $2,000 in debt on one card, you were able to successfully slash your debt from $7,000 to the point where you now owe $5,000 altogether. When compared with your total combined credit limits of $20,000, that $5,000 is just 25 percent of your limits, putting you well within the acceptable range. But if you then close the account, you will owe that same $5,000 on accounts with limits totaling just $15,000, giving you a utilization ratio of 33.3 percent, and putting you right back above that limit.

Therefore, you'll have to think very carefully about such a decision, as it will likely have a massive impact on your credit scores if you're not careful, and thus necessitate further work to fix credit you just worked so hard to improve.

Another potential problem
Closing your accounts can also hurt your credit in another way. This is because 15 percent of your score is also made up of just how long you've had your accounts on average. That means that if you close an account you've had for a particularly long time, you might end up dinging your score in this way as well, and as a result, you should carefully consider such a decision.

It may be worth it to keep the accounts in question open as long as possible but maintain a zero balance on them. In the case of one man named Dale in Oregon, who had a whopping 20 cards in his name, even missteps in shutting one of those accounts were keeping him from making a hasty decision, according to a report from the Oregonian. Obviously, having 20 cards at any one time is likely too many for any person to handle capably, but if such a decision would impact your average account age or – more importantly – credit utilization ratio, you'll need to carefully consider your next move to protect your credit.

Of course, you should also try to check your credit reports regularly as well. Doing so may help you identify any unfair markings, and if they appear on the documents, working with a credit repair company may help sort them out.

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