Credit scores are a funny thing (not funny haha, but funny weird). You need to be indebted in order to build up your credit history, but doing so, puts you in a risky position. If you want to buy a house, a car or get a student loan, you need to have built your credit history, so millions of Americans spend their financial lives doing this dance in which they have little to no knowledge of the steps.
Let's imagine you are a responsible American and you open a handful of accounts. You charge a few things and pay them off on time at the end of each month (just to build up your credit, you know). You then charge some more, but instead of paying the balance at the end of the month, you pay the minimum charge. It was a tough month after all with having had to replace the tires in your car. When you least expect it, it has been months since you have paid a dime over your minimum payment and your balance isn't going down, so you make a plan to pay off the debt. A year later, you've been disciplined and you've managed to pay off your credit card debt. Your balance is now zero. Should you close the account then? I mean, you don't want to get back in debt, do you? Don't be so quick. Before you decide to close an account with a debtor, consider this:
One of the major components of your credit score is what is knows as credit-utilization rate (balance to limit ratio). When you close an account that has a zero balance, you essentially lose the available limit in that account, causing your overall utilization rate to go up and your credit score to dip. If all your other accounts are positive, your score will typically bounce back after a few billing cycles. If you are thinking of closing an account, consider two things
- When will you need your credit score. If you are planning to finance a house in the next 3 to 6 months, do not close the account
- How much of your overall available credit does that account represent? If the account in questions represents a small portion of your overall available credit, closing it could have very little impact, but if the account represents a large portion of your credit history, then the negative impact could be significant.
- How long has the account been open for? The length of time you've had the account in questions open has an impact on your credit score and closing an account that has a long history may negatively affect your score.