The NFCC often receives readers questions asking us what they should do in their money situation. We pick some to share that others could be asking themselves and hope to help many in sharing these answers.
This week’s question: I heard my friend closed her oldest credit card of 4 years and lost all of that credit and her credit score went down. I have one year of credit on a credit card that has a $98 fee after one year, if I close the card do I lose all my credit?
Generally, you can expect your score to drop when you close a credit card, especially if it is your only credit card. So, consider keeping it open. However, if you are primarily motivated to close this credit card to avoid the $98 annual fee, you may have the option to downgrade your credit card for one that doesn’t have an annual fee. Contact your credit card and ask about your options. This way, you can keep your account and its history on your credit report. You could also consider adding another credit line to help you establish a new credit history if you need to close your credit card for good.
But there are more critical factors that impact your score. Understanding what factors influence your credit score can help you understand how your credit score could be affected if you close a credit card and what you can do to build it back up.
What goes into your credit score
Your score is calculated using a secret formula based on the information on your credit reports. Five common factors influence your credit score. Below, we explain how these factors affect your FICO score, which is the scoring model most lenders use. Other scoring models, such as the VantageScore, use a similar system to calculate your scores.
- Payment history (35%): This part of your score takes into consideration whether you make on-time and complete payments every month. Late or missed payments lower your score and stay in your report for 24 months. When you close a credit card, your past credit history it’s not erased. Instead, it stays in your report for seven years, influencing your score to a lesser degree. But, if you close your only credit line, your score will likely suffer more because you won’t have any monthly activity to use to calculate your new score.
- Amounts owed or utilization ratio (30%): This category factors how much credit you use compared to your available credit. It’s calculated by adding all of your credit card debt and dividing it by your overall available credit. Creditors like to see that you use little of your available credit. Ideally, you should use less than 30%. For instance, let’s say you have two credit cards with a credit limit of $1,000 each and $500 debt in one of your cards. In this scenario, you have $1,500 in available credit, equal to a 25% utilization ratio. Suppose you close one of those credit cards (even if it has a balance). In that case, you are decreasing your total available credit by $1,000, increasing your utilization ratio to 50%, lowering your score.
- Credit history length (15%): This percentage of your score is set by how long you have had accounts reporting to your credit file. Influencing factors include the age of your oldest account, the newest, and an average of the other accounts. So, closing your oldest account can directly affect your credit history length, shortening it. Generally, the older your credit history, the better it’s for your score. The only way to create a long history is to be patient as time goes by.
- The credit mix (10%): Diversity in your credit lines may not be the greatest influencer of your credit score, but it does make a difference. Ideally, it would be best to have a healthy mix of revolving credit (your credit cards) and installment loans, such as mortgages, car loans, and student loans. There’s no set rule of how many credit cards or loans you need to have.
- New credit (10%): How often you ask for new credit defines this category. Any new credit request generates a hard inquiry in your report, which stays there for 24 months. Too many inquiries in a short period not only brings your score down but makes you look like a risky borrower because it seems that you are borrowing too much too fast.
Now that you have a better understanding of what goes into your score, you have more insight into how closing your credit card can affect you. Remember, your best strategy will depend on why you want to close your account, your current credit report, and your financial goals. If you need additional guidance, talk to an NFCC Certified Financial counselor by visiting NFCC.org or calling 800-388-2227. Your counselor can review your credit report to help you decide what works best for you.
If you have a question, please submit it on our Ask an Expert page here.