When is it Bad to Kill a Credit Card Account?

Dear Credit Card Adviser, I have six unsecured credit cards I plan to pay off this year. I have a long history with two of the credit cards. I would like to keep one of them with the highest limit for emergencies. I'm confused about what to do because in the next year or so, I plan to purchase my first home. I have heard so many stories about not closing them because it could drop my credit score. I feel that once paid in full, I should close the cards because there's no need to keep them open. Plus, I still get charged a monthly fee of $6 per card whether I use it or not. Please give me a better understanding of how I should handle closing the credit cards for my future housebuying. Thanks. -- Belen

Dear Belen, It's great you're trying to get your cards in order, so to speak, long before applying for a home loan. One factor your lender will consider is your credit score. For that reason, you'll want to avoid making mistakes that could cost you a lower interest rate on your mortgage.

One of those potential mistakes is closing credit card accounts without understanding how it will affect your score. Closing a credit card account by itself may not improve your credit score much. The impact may be minimal, depending on how much you owe on remaining credit cards at the time of closure.

According to myFICO.com, the popular credit score website, the amounts you owe make up 30% of your credit score.

One major component in this category is how much you owe compared to your credit limits on revolving accounts such as credit cards. That ratio is figured for each credit card and across all of your credit cards. A lower utilization ratio is better for your score.

When you close a credit card account you've paid off, the credit limit from that account will no longer count toward your overall utilization. This change can inflate your utilization ratio even though you haven't taken on any additional debt.

Before closing any accounts, consider your utilization on remaining accounts. If utilization is low on individual cards and as a whole on all credit cards, it's less likely closing any account will hurt the score, says Barry Paperno, consumer affairs manager at myFICO.com. "If your utilization is under 25%, you're less likely to hurt your score," he says.

It doesn't matter so much when you shut down accounts. Closed credit card accounts can stay on your credit report for up to 10 years. While they're on your report, they will continue to factor into the major score categories such as length of payment history and mix of credit, with the exception of utilization.

What's more, if there is an increase in utilization when you close some accounts, it's not a life sentence. "There's no history associated with utilization," Paperno says. By paying down remaining card balances (or charging less if you're paying balances in full each month) after shuttering some accounts, you can recover from any temporary surge in utilization.

Ideally, you would keep those accounts with high limits and long payment histories. Closing high-limit credit cards can affect overall utilization more than low-limit cards. And when closed accounts eventually come off your credit report, it could have an adverse affect on your length of credit history.

Other credit pointers:

• Keep an eye on your credit reports. Because your reports can contain score-damaging errors, it's a good idea to check your reports periodically and dispute any inaccuracies. Under federal law, you have the right to request a free copy of your credit report from the three major credit reporting agencies once every 12 months. Head to AnnualCreditReport.com to order your free copies.
• Always pay on time, even if you can only make the minimum payment. A single 30-day late payment can pummel your credit score.
• Pay down credit card balances. Once they're paid off, use them as lightly as possible.
• Avoid seeking new credit in the months leading up to a home loan application. Paperno says he "definitely" would avoid applying for new credit within six months and ideally as much as a year in advance.
• Check your credit score if you want specifics on how to improve it. Your score will come with several reason codes or score factors -- the key reasons your credit score isn't higher.

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