Following the same train of thought as a recent post concerning establishing or improving your credit, there is one common mistake many people make – closing paid-off credit card accounts; particularly, accounts which have been open for several years. According to some credit experts, based on your individual financial situation, closing credit accounts could be the largest credit mistake you did not realize you were making!
Many individuals are under the misconception that once a credit card is paid off it is better to close the account rather than taking the chance you might have a weak moment and use the card again. If this is a concern, place the card in a location which would be difficult or time consuming to access. I have several friends who actually placed their paid-off credit card in water then froze it to ensure it would take some effort to be able to use that particular card. I personally would not go through that much effort just to prevent myself from using a card so I just removed the card from my purse and placed it in a small fire safe. I did however make a notation on my calendar six months in the future to use the card for a small purchase. This ensures I am able to keep the card active so the issuing company will not cancel the card due to inactivity. I am a firm believer in using each of my cards approximately every six months for a small purchase to keep the card active then paying the card off when the bills arrives so no interest is accrued.
The reason not to close a paid-off account is due to the fact approximately 30% of your credit score is based on a ratio called the credit utilization ratio. This ratio is comprised of the relationship between your available credit and the amount you have used or utilized thus the name utilization ratio. Closing a paid-off card will reduce your available credit while the balance owed on your other cards will remain the same. For example, if you have $16,000 available between three credit card accounts and you currently owe a balance of $4,000 on two cards your utilization ratio is around 25%. If the paid-off card has a $10,000 limit and you close that card, your available credit is now $6,000 and your utilization ratio immediately jumps to 67%. This will definitely hurt your score. The ideal ratio is under 30% as any percentage over 30% will hurt your credit score.
It certainly is an excellent idea to pay off credit cards to reduce debt but rather than immediately closing the account find a method to help you to avoid the temptation of using the card again but do not close the account and in the process hurt your credit score! Credit is an asset which must be used wisely to achieve your goals while maintaining financial security.
Leave a Reply