Its still confusing to me, I pulled up a nice article that explains the whole process of closing a credit card.
I will highlight the inportant parts.
1. Closing Credit Cards Accounts
Some of you may wonder why Closing Credit Cards is number one on this list as the biggest credit mistake even above Missing Payments. In fact, closing credit cards is almost as bad of an idea to increase your credit scores as missing payments, but it is also a clear number one on the list of credit myths. It is perhaps the most common piece of advice that consumers are given when they ask,” How can I increase my credit scores?”. If there were ever a wolf in sheep’s closing as far as credit mistakes go, it’s this one. Closing credit card accounts will not increase your credit scores. So called “industry experts” such as mortgage lenders suggest that you close credit cards as a strategy to increase your credit scores to qualify for home loans. However, there are two huge reasons not to close credit cards that you no longer use. They are:
They will eventually fall off your credit reports – Information on your credit reports has to follow certain rules as far as how long it can remain on the report. In most cases credit information will remain on your credit files for no longer than seven years from the account’s Date of Last Activity or “DLA.” Your DLA will continue to update each month so long as the account remains open. So, an open account will never reach the seven-year mark because each month your DLA updates to the current month. However, once you close the account your DLA will cease to update and the clock begins ticking. Eventually the account will be removed permanently from your credit reports.
Why is this a bad thing? The answer to this one is very simple. It’s all about your impressive past. Here’s an analogy that might make this easier to understand. Let’s say hypothetically that you made straight A’s in high school. What if the record of that perfect scholastic accomplishment were permanently deleted seven years after you graduated? Would you ever want that history deleted? Of course you wouldn’t. This also applies in the credit reporting environment. If you have a perfect record of making your payments on time then this significantly helps your credit scores so why would you ever want that history to disappear? You wouldn’t.
What should you do with old credit cards that you don’t use any longer? The problem with inactive credit cards is that you are not generating any revenue for the credit card company. Eventually they will proactively close the unused account because you are a liability, not an assehistory.t. Prevent this from happening by using the card once every few months for dinner or a low dollar item like socks or a new belt. Once the bill comes, pay it in full. Doing this will ensure that the account will never be closed and you’ll always get credit for your good payment
You will hurt your “utilization” measurements – This is significantly more important than your closed accounts eventually falling off your credit reports. Revolving Utilization is the amount of your revolving credit card limits that you are currently making use of. For example, if you have an open credit card with a $2,000 credit limit and a $1,000 balance then you are 50% “utilized” on that account because you’re using half of the credit limit. This measurement is almost as important to your credit scores as making your payments on time. If you had a second open, but unused, credit card with a $2000 credit limit and a $0 balance then your aggregate revolving utilization is 25% because you have $4000 in credit limits and $1000 in balances. $1000 divided by $4000 is .25 or 25%.
How will closing an unused credit card hurt your credit score? Let’s say that you closed that second unused credit card from the above example. Once you do so then you remove it from any utilization calculation and now you’re stuck with one open card with a $2000 credit limit and a $1000 balance. Now your utilization has gone from 25% to 50% (divide $1000 by $2000 and you get .50 or 50%). As this percentage increases, your credit score decreases.
2. Missing Payments
The reason missing payments is number two on the list instead of number one is that it doesn’t take a credit scoring expert to tell you that missing payments is a bad thing. It’s common sense, unlike Closing Credit Card Accounts. The explanation why missing payments is a huge mistake is also fairly obvious. Credit scores look at your credit history to see how you have managed your current and past credit obligations in an effort to predict how likely you are to miss payments in the future. The most powerful “predictor” of future late payments is having missed payments in your past. There are three ways that missing payments will hurt your credit scores. They are:
How Frequent are Your Late Payments? – If you miss payments frequently then you will be penalized much more severely than someone who misses payments infrequently. Missing payments every once in a while indicates that you are a responsible consumer but you may have problems with finding the time to make your payments. Or, perhaps the bill was lost in the mail or you were out of town on travel when the bill came due. The point is that you are not making a habit of missing payments. Don’t start.
How Recent are Your Late Payments? – Since scoring models are designed to predict how you are going to pay your bills in the subsequent 24 months, it’s very common that they assign more value to how you’ve managed your credit in the most recent two years. If you have late payments that have occurred in the most recent two years then you are more likely to miss more payments in the next two years. As such, your score will suffer.
How Severe are Your Late Payments? – The severity of your late payment also plays a big part in your credit scores. This not only makes statistical sense but also common sense. Consumers who have missed payments by only a few weeks and then bring their payments up to date are going to score better than consumers who have payments that are 90 days past due or worse. If you have late payments it is in your best interest to do all that you can to bring them up to date.
3. Settling With Your Lender on a Past due Account
“Settling” is a term used in the consumer credit industry that means accepting less than the amount you owe on an account. For example, if you owe a credit card company $10,000 but you can’t pay them the full amount then they will likely make you a deal for less than that full amount. They have “settled” for less than the full amount, which is likely much less than you contractually owe them. This may seem like a good idea because you are happy that you didn’t have to pay the full amount. However, the lender will report that remaining amount to the credit bureaus as a negative item. This remaining amount is called the “deficiency balance”. A deficiency balance is considered just as negatively by credit scoring models as any other severe late payments. If you can arrange a deal with your lender so that they will NOT report the deficiency balance then that will be your best course of action. If they will not agree to this then you have to figure out a way to pay them in full or your credit will suffer for 7 years.
4. Over Utilization of Your Available Credit Card Limits
Having high balances on your credit cards will undoubtedly cause your credit scores to go down, and in most cases, in a big way. The mistake you are making is called “over utilization.” Over utilization is the practice of running up balances too close to your credit card limits. For example, if you have a Visa card with a credit limit of $10,000 and a $5,000 balance you have a utilization percentage of 50% because you are using 50% of your credit limit. The higher that percentage the fewer points you will earn for your credit scores. If your balance is $9,500 then you will be 95% utilized and in big trouble. Your best bet would be to use your cards sparingly and pay them down as much as possible each month. If paying your cards off every month is unrealistic then try your best to keep that percentage as low as possible. There is no magic target to shoot at, but it’s safe to say that the lower the percentage the better
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