The Surprising Thing That Could Hurt Your Credit Score

Credit & Debt
on April 10, 2014

Surprising Mistake That Could Damage Your Credit Score

Thinkstock.com

The credit scoring process is a far cry from “intuitive,” and we’ve certainly never heard it described as “transparent.” So it should come as no shock that even the most well-intentioned money move could do real damage to your credit score—a precious commodity in today’s financial landscape.

Among the main factors weighted against your credit score, one is your credit utilization ratio—or “amounts owed”—a factor that accounts for a whopping 30 percent of your FICO score, the indicator used by the majority of lenders. Your credit utilization ratio represents the amount of credit you have available, compared to the amount you are actually using.

See where we’re going with this?

While canceling a credit card may feel like a solid money move (especially if it’s seeing way too much action) we regret to inform that feelings have no place in the credit scoring game. Before canceling that card, you’ll want to closely evaluate your overall credit history and availability (which should be easy, because you’re taking advantage of your free annual credit reports … right?).

To find your credit utilization ratio, simply divide your current credit card balance by the total credit limit available across all accounts. So if you have $1000 in available credit, and your current balance is $300, that would make your current utilization ratio 30 percent (300/1000). Canceling a card will lower your available credit, which will raise your utilization ratio. That, in turn, could damage your overall credit score—but that’s not to say that closing accounts is an assured kiss of death.

“If you have a credit utilization ratio that’s 30 percent or below, you’re going to be in good shape. But the closer to ten percent, the better,” says Beverly Harzog, finance expert and author of Confessions of a Credit Junkie.

So when is a good time to cancel a credit card?

“I never say never, because there are always exceptions,” says Harzog. “If you have a high annual fee on a credit card that no longer suits your lifestyle, it might be something to consider. But I would say it would have to be a big annual fee.”

The next exception would be, well, if you’ve acknowledged that you … have a problem.

“There are people that pay off their balances and get right back into debt. If you feel that you’re in that kind of pattern, do what you have to do,” says Harzog. “I would say it’s okay to close an account, and go ahead and take the credit score hit, if you must, to keep yourself from getting back into debt … But if you do decide you need to, don’t close a card right before you try to get a personal loan.”

From there, Harzog accords another trick of the trade that could offset any damage to your credit utilization ratio—simply replace the available credit, a good option for those determined to rid themselves of annual fees incurred for rewards programs that no longer suit their lifestyle.

Read: Open a new card, one that does make sense for you. And then use it responsibly, paying off balances each month.

But unless you fit that description—or if you’ve effectively become a credit junkie, stuck in a cycle of debt—think long and hard before canceling that card. Canceling may reduce the temptation to lay down plastic for every purchase, but it could do more harm than good.

For more on Beverly Harzog, visit her website at www.beverlyharzog.com.

Related Articles: Bad Credit vs. No Credit, Making the Most of Your Credit Card

 

Found in: Credit & Debt
%d bloggers like this: