Must We Cancel Cards to Refi?

Dear Credit Card Adviser,

We are refinancing our home. The bank requires that we pay off and close our revolving credit cards. Will this hurt our credit score? We would like to reopen at least one in case of emergency.

-Janice

Dear Janice,

If you close all your cards and have no revolving accounts, there's a chance it could hurt your credit score eventually because you won't get the benefit of showing responsible payment history on an active account, says Anthony Sprauve, senior consumer credit specialist at FICO.

"It's generally better to show moderate and responsible use of revolving credit than having no recent use of revolving credit," he says.

If you want to open a new card for emergencies, your credit score will get hit for sure. Every time you apply for new credit, the lender requests your credit report, a process called a hard inquiry. Each hard inquiry lowers your credit score and remains on your credit file for two years. If this ends up being the case, I strongly recommend you wait until the refinancing is completed before opening a new credit card. Otherwise, you could derail the refinancing if the lender notices that you applied for a new credit card and your credit score is lower.

Now, if the bank wants you to close only the credit cards with the highest balances, but other cards can remain open, then you run the risk of a higher utilization rate down the road, which also dents your credit score. That rate is the percentage of available credit that you use. The key is to keep that rate below 20%.

For example, say you have four cards that have $1,000 in credit limits. If you regularly charge $800 every month across the cards, then your utilization rate is 20%. But if you have to close two of those cards and your monthly charges remain unchanged, then you're using 40% of your available credit. Close three cards and you're using 80% of your credit. That will ding your credit score.

To mitigate the effect to your utilization rate, ask your other credit card companies if they would consider a credit limit increase. You could also apply for a new credit card -- again, after the refinancing has closed -- to add more available credit to your credit file. Just make sure to responsibly handle any new credit.

With all that said, this is a strange request from a bank. Two mortgage professionals I spoke with said that it's not unusual for a bank to require you to pay off your credit card balances to lower your debt-to-income ratio, but they never heard of banks asking applicants to close their cards.

"I've heard of a lot of reasons why loans get denied, and having too many credit cards is not one of them," says John Stearns, Mortgage Banker at American Fidelity Mortgage in Wisconsin. "Having too much credit card debt is, though."

Go back to your bank and ask for a clarification. Maybe just paying off your credit card debt is enough to get the refinancing done.

Good luck.

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