Tuesday, August 12, 2008

How Closed Credit Cards Impact Your FICO Score

I've alluded to this topic on several occasions in the past. My previous blog entries are riddled with references to closing credit-card accounts. Today, we tackle the issue head on.

Let's isolate the two important issues that crop up as a result of account closures. One, your utilization ratio will be impacted. Two, eventually your closed account will get deleted from your credit history.

Utilization will be your most immediate concern, since closing an account takes the credit limit out of the FICO equation (assuming there is no balance on the card when it's closed). Longer term, the closed account will ultimately fall from your credit history, which could impact the average age and length of your credit history (FICO takes both into account). (Not all credit cards report as "revolving," by the way. My Nordstrom Visa Signature (link here) card, which doesn't have a preset spending limit, reports as "Open" on my TransUnion and Equifax credit reports. As a result, my balances don't hurt my utilization ratio. For this column's purposes, though, we'll assume that all cards are treated as revolving.)

We'll look at utilization first. When you close an account, the credit limit on that closed account is no longer factored into the FICO equation. As a hypothetical, imagine that we have four credit cards. Credit card A has a credit limit of $10,000. Credit card B has a limit of $5,000. Credit card C has a limit of $5,000. And credit card D has a limit of $10,000. Further, let's imagine that credit card A has a balance of $6,000. Credit card B has a balance of $2,000. Credit card C has a balance of $2,000. Finally, credit card D had no balance. In sum, the total balance for all four cards is $10,000. In all, utilization is 33% ($10,000 used on $30,000 in credit limits).

For whatever reason, you decide to close credit card D. Now, instead of having $30,000 in available credit, you have $20,000. Worse, your utilization ratio, which was already moving toward the high side at 33%, jumps to 50%. Instead of having $10,000 in balances spread among $30,000 in available credit, you now have $10,000 in balances spread among $20,000. Oops. Assuming nothing else changes on your credit report, it's safe to assume that your FICO score will take a hit when the creditor reports the closed account and the new utilization ratio is computed. Given that utilization accounts for 30% of your FICO score, this shouldn't come as a surprise. I typically advise people to get credit-limit increases on the cards that will remain open. That way the person can mitigate the impact that losing $10,000 will have on overall utilization.

And this note: closed accounts with no balances are not included in the FICO utilization calculation (link here), but closed accounts with balances are! The danger in closing an account with a balance is that the card company could (and likely will) report your limit as $0 -- while also reporting the balance. If that happens, it will appear as though your card is completely maxed out.

As for your credit history, the ill-effects of closing credit card D won't be felt for some time. That's because the credit card, and its history, will remain on your credit report for about ten years more (though, alas, I've seen them fall off sooner). Ten years after closing your account, though, your score could take a hit -- albeit a smaller one -- when the card gets deleted from your credit report. (Length of credit history accounts for 15% of your FICO score.) This assumes that the account that falls off lowers the average age of your history or happens to be your oldest account. Indeed, if all of your accounts were ten years old when you closed credit card D, and you added no new accounts afterward, there would be no change in the average age of your accounts. Ditto length of history. They'd all be, on average, 20 years old when that fourth card fell off your credit report (remember that closed accounts age until the day they fall off the credit report). Thus, there would be no change.

The trouble occurs when you close one of your cards and then add new cards later. Under that scenario, it's easy to see why an old, closed account can harm your score when it gets deleted. A simple illustration should serve us well. Let's pretend that you disavowed credit because of a radio broadcast you heard. You took your only credit card, which was ten years old, and closed it -- chopping it into little pieces. You used cash from then on.

Now let's fast forward ten years. You come across an awesome blog called GlobCredit.com. There, you learn that having credit is actually a good thing. That it is an important thing. Excited, you decide to open a new credit card. The two cards, the closed card that is almost 20 years old now (which is contributing so positively to your length of history), and the new one, give you an average age of 10 years. The following day, your oldest card (the closed one) finally falls off your credit report. All you're left with is one card, which is just a day old. Sadly, it now looks as though you're a credit newbie. The average age of your account can't even be computed, since there is nothing to average, and the length of your history now weighs in at a whopping day.

We can play around with all kinds of scenarios, plugging in all kinds of numbers, but there is no way around it. Keeping older accounts open is important. Unless your oldest account is fee ridden (and you can't get the company to waive the fee), I'd find a way to keep the card open. Also, even if your account has blemishes (lates, for example), you're still being helped in the age department. These accounts continue to help the age component of your credit history. Likewise, closing derogatory accounts doesn't make the negative history go away. Only time can do that.

I wish I knew then what I know now. I thought that closing older accounts (that I wasn't using much) made sense. I thought that closing accounts was the right thing to do. Turns out that I couldn't have been more wrong. Instead of having a bunch of accounts that are 20 years old, I now have cards that are closer to 10 years old.

Learn from my mistakes. Close older accounts only when it's absolutely necessary. Otherwise, leave them alone.

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lupoman said...

GREAT article as always bud!!

Its very hard to explain to people why they need credit. "If i need a credit card to buy something, and cant afford to pay cash for it, then I don't need it." But when you get to the root of their thinking, it usually ends up that they had credit cards before and had no self control and spent beyond their means. It left a bad taste in their mouth.

I find myself looking at my credit reports looking at my old $300 limit Capital One cards wishing I had the age on them lol. My oldest open account was opened in 2000. My oldest closed credit card was opened in 1993! BAH! (it was a paid charge off though). Wish I had that age!!

Like you said, "wish i knew then what i know now!"

James said...

Let's pretend that you disavowed credit because of a radio broadcast you heard.

Haha! I see what you did there. :-)

Credit Matters said...

James, ha! Are we having fun yet? :)

Glad you enjoyed the article.

And thanks for reading.

Credit Matters said...

Lupo, I opened my first card in 1986. It's no longer with me. My next one was opened in 1987. Gone. I only have one left -- and it was opened in 1989. It remains open.

Were it not for that card, my length of credit history would be 10 years. As it stands, my length of credit history is, luckily, 19 years.

Thanks for reading, as always.

SpaghettiBender said...

This is concerning for me. I had a bk in 1999, and didn't start rebuilding till last November!
There are several cards that were paid off and closed during that time as well.
Eventually those paid off years ago, and then closed out will affect me, right? I am sitting at a 728 average FICO.
I imagine some of those old closed cards are helping with this.

Can I expect a significant drop in scores when those fall off my report some time in the future?

Credit Matters said...

SB, length of credit history accounts for 15% of your score.

I'd imagine, from what you've said here, that your score will take a small hit eventually. This is one of the caveats that I talk about when someone goes BK or swears off credit for a long period of time.

For now those closed accounts are helping you with age, SB. But when they fall off, the average age of your accounts and the length of history will be shortened.

Do you have any opened accounts from 1999 (or thereabouts)? Or were they all closed? If all of those accounts fell off today, how old would your oldest account be?

Brian said...

So, this doesn't directly relate, but I'm curious - have you ever been denied a new card for having too much credit?

Credit Matters said...

Brian, yes. That happened to me last October.

Let me preface my remarks by saying that I have only been denied once for this reason. Indeed, I have only been denied credit once in the past 2.5 years.

But here's the story on the credit denial: I applied for a Citi Business card. At the same time, I applied for a Chase business card and a Bank of America business card. I was approved for both the Chase card and the BOA card. Both with healthy limits.

I called to find out why I was denied a card at Citi. The underwriter point blank told me that I have enough credit. In fact, if I would close some of my other cards, then Citi would reassess my application. Uh, no. I told Citi that I was not interested.

During the past ten years, I have been denied credit four times. Twice with Discover (for too much utilization). Once with CapOne (also too much utilization). And Citi (for too much credit).

With the Discover and CapOne denials, I did have high utilization. There was something I could do about it, though. I paid down my balances and haven't looked back.

Having too much credit, the reason that Citi used to deny me, is not something that I can change. I am not going to close a bunch of cards just so that I can please one analyst at Citibank.

Brian, I hope this answers your question.

Brian said...

It does, thanks. I was hesitant to post that because I don't want to dissuade people from applying for credit, but I figured it was worth asking.

Credit Matters said...

Brian, I know people who have more available credit than I do. Many of them have never been denied for too much credit. In some cases, these people have more than $1MM in available credit.

I guess what I am saying is that it's a rarity to be denied because of too much credit.

Marat said...

Marcus, great read!
A question. Is there any difference how FICO treats different acounts, I mean charge vs revolving vs installment.
Let me be more specific.
I am very itchy to close my GEMB accounts, it won't worsen my util (I am PIFer, besides my revolving CL more than 120k and combined GEMB CL is $3550), no rewards, no CLI, BUT...
My credit history very short like 28 mos. JCP is my 3d oldest account and walmart 5th oldest.
Any word of wisdom will be highly appreciated.

Credit Matters said...

Marat, unless there are fees associated with the card, and there is just no way that the card will ever grow with you, I would advise keeping it open. These cards will eventually turn into old cards. Time is on your side.

As for installment, charge, revolving, be a little more specific so that I can answer your question intelligently. These are treated differently in the FICO calculation. Installment accounts, for example, are minor when it comes to the utilization ratio. Revolving is where all of the points counts.

But give me a concrete example of what you're asking.

Thanks, M.

Far Left Texas said...

In 1979 when I turned 19, I received my first CC, a JC Penney card. Two years later I had a Chevron card, a local department store card, and in 1981 I received my first Visa - America West Airlines Visa.

In 1996 (don't ask me why, it seemed like a good idea at the time) I decided to cull my herd and I canceled about 8 or 10 credit cards, including the oldest ones.

Fast forward to 2008 and guess what? My credit history is 18 years and it could have been 29 years had I hung onto that Penney's card.

Oh well.

But my wife and I are going to carefully add each other to our good trade lines. My wife's parents got her a JCP card when she was 11 years old. Since she's ten years older than I am, hopefully this 48 year-old's credit history will soon be 46 years!

Credit Matters - An article on the pros and cons of AUs (and FICO08) would be good subject matter.

And - you've heard it before and you will hear it again - You have the BEST blog on credit anywhere in/on the entire internet. Thanks for writing it and thanks for letting us read it.

Credit Matters said...

Far Left Texas, I am humbled by your words. Not sure if this is the best credit blog on the Interest -- that's high praise, indeed -- but I do try my best. Thanks for the kind words, though.

As for your situation, wow. I bet you wish you had some of those older tradelines back. But, I imagine that you're doing just fine with 18-year-old tradelines. FICO High Achievers (the topic of my blog tomorrow), on average, have a length of credit history that is 19 years old. You're right there. So, no worries.

Finally, I'll be writing an article about authorized users soon. I already have all of my stories for this week and next week completed. Thus, my AU story won't appear until Aug. 25. But it's something that is definitely getting written.

Thanks for reading.

TheVibeRAIDER said...

A few years ago, I read from several articles that it would be "better" to close accounts that I hardly ever use. I had 2 FirstUSA and 1 Bank One accounts from the 1990s. I'm not sure if I closed the Bank One card prior to it being acquired by Chase, but I only realized it when I signed up on Chase's website when FirstUSA became Chase and I saw 3 accounts!. I only discovered this year that I could combine my cards with Chase. If only I kept that Bank One card opened, I would have had a $65,000 credit card dating from the 1990's!

Another card I had from the 1990's was MBNA (now BofA). It had a $25,000 CL. I also had an AMEX that I closed in 1992. I wish I kept them all opened. I was a victim of mis-information!

What I have now, I will use them in a rotational basis. My sock drawer deserves to be cleaned once in awhile.

Credit Matters said...

VibeRaider, welcome to Credit Matters.

I'm with you. I didn't realize how important it was to keep my older accounts open. About five days before I found CB, I closed an old account. Haha. So smart. Not!

My oldest reporting card is now nearly 20 years old. But I used to have three of those. I let them go inactive and eventually they got closed. Now I know better.

By the way, I'd feel more sorry for you, but I know your FICO scores! Oh, that we could all have your problems. Are you above 840 on all of your scores right now?

TheVibeRAIDER said...

Thank you for the welcome, Credit Matters!

I think you meant to say you know my PFICO from my postings at CreditBoards, because if you do know my FICOs, I sure would like to know!

As far as my classic FICOs, I don't have an answer yet. I just opened a 25K PenFed card, thanks to both you and CreditBoards. I might get a big hit on my scores, so I doubt I have more than 840.

Credit Matters said...

Vibe, when you find out, be sure to post them here. I'm curious.

And congrats on the Penfed approval.

TheVibeRAIDER said...

I realized just now that I had one CC closed by HSBC due to non-use, back in Jan. 2008. I was going through my files when I noticed a letter stating as such.

Not sure how much of an impact it affected my FICO, but that's $10,000 down the drain. I don't remember when I opened it. At the time, I didn't care, because I try to keep a low utilization.

Reading Credit Matters and CreditBoards has changed my credit habits. I used to be content with one main card, rarely using my other cards. With the current financial climate, I intend to be more flexible in my way of thinking.

Credit Matters said...

Vibe, now more than ever it makes sense to use some of those old cards. It's anyone's guess as to how card companies are going to handle this crisis. I don't want to guess what criteria they're using for account closures.

deerfern said...

8 months and 2 weeks I will have a card 30 years. It's my Sears Card. It's a small CLI but that's ok. I had one other card 1 year earlier than it and due to my getting upset at the retailer, I cancelled it. Wish I hadn't done that now, but I'm ok with the Sears Card. Now to just get the CL up.

GlobCredit.com said...

Deerfern, no big deal there. Fact is, you only lost one year of history by closing the oldest card. What's more, it remains on your record for ten years from date of closure.

No worries at all.

And good luck on getting the Sears credit limit up a bit. I would imagine it would not be tough since it's so old. You're probably a great customer. They'd hate to lose you.

Anonymous said...

Hey Marcus-- it's nearly 9pm est and I can't believe I'm back on your blog!! This has been such an eye-opening experience. Question. I was recently approved for a Nordstrom VISA, as you know (this is John) with a $500.00 limit and just as you said, was told in 7 months to follow up for a credit increase. Does it make send to you to have my first purchase be at Nordstrom?? Thanks again!!

GlobCredit.com said...

A first purchase at Nordstrom would be excellent. Nothing wrong with using a Nordy card at Nordys.

Congrats again on the approval.

Anonymous said...

Thanks!!! I am excited, too. I had the card with them for 10 years (with no issues and didn't include them in the BK--so, I am greatful to them for the opportunity again--especially given how highly rated they are. In any event, I have and continue to shop there, so I guess I'll find a Christmas present to buy for someone. I hate to keep asking you questions, but does it make sens to you to pay off the balance immediately after use or wait for the statement to cut? I don't want them to report me as using up my entire line...I am amazed at how fast you reply to your fans!! --John

GlobCredit.com said...

John, in this particular case, because the limit is on the lower side, you might be wise to pay the balance before the statement closes. After several months of using the card, you might want to call Nordstrom and ask them to lift your limit.

Tell them that you are having trouble with the limit and utilization. That's why you've been paying the bill before the statement cuts. They'll have your payment record and realize that you're doing just that.

Good luck, J.

And I do respond to all of the comments that are directed toward me. I get an email alert anytime there is a new comment. Tomorrow I have a final exam in the morning, so I won't be around for several hours.

Anonymous said...

Thanks a million, Marcus. Best of luck on your exam tomorrow!! I've been reading PowerScore books to prep me for the LSAT in Feb, which for you must seem like a thousand years ago. Btw, do your classmates and professors know about your famous blog?? Just curious... Thanks again!!

GlobCredit.com said...

I only have one semester left of school, so the LSAT does seem like a long time around. It's been more than three years since I took it.

As for my colleagues and professors, I don't publicize my blog very much. I'd be surprised if more than a handful of my colleagues know about it. I'd be shocked if any of my professors knew about it.

For the most part, I don't market my blog at all. My blog has mostly grown through word of mouth.

xelda said...

This is definitely one of my most favorite articles on your blog. Maybe you should compile a Top 10 list to keep on the main page.

GlobCredit.com said...

xelda, I used to have a top-10 link on the site (on main page). I took it down because most of my readers did not click it. It was just taking up space.

However, I do have a link for the actual page:

The 10 Most Important Stories Written By GlobCredit.com


xelda said...

Thanks for the link. I've read all of those articles before, but it's helpful to reread them.

GlobCredit.com said...

xelda, glad you enjoy the older stuff.

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