The average American has four credit cards. Some they may use rarely, or not at all. Closing those unused accounts is a good idea, but you have to do it right.
People often procrastinate on this because they know it will affect their credit score, although very often they’re not sure why.
As Christians, we take Proverbs 3:27 seriously, “Do not withhold good from those to whom it is due, when it is in your power to do it.” Closing out an account with a zero balance means you’ve already paid back the money.
Why then should your credit score drop? It seems like you’re being punished for doing a good thing, but it really comes down to mathematics and complicated computer algorithms.
An algorithm lives inside a computer model and is just a set of rules that solve a problem in a limited number of steps. Among other things, those computer models give you more credit score points for having three things: long standing accounts, more available credit and more kinds of accounts, such as a credit card, auto loan and mortgage.
The longer you have an account open, the more credit you don’t use and the more types of accounts you have, the higher your score. Those three factors alone make up 55% of your FICO score. That’s because having older accounts, a lot of unused credit and more kinds of accounts tells lenders that you’re likely to pay them back.
Do you really need to worry about this when you close an account that results in a slight drop in your credit score? Usually not, but there’s one occasion when it could be important.
If you’re shopping for a mortgage or some other kind of loan, you want the highest score possible. Lowering your score by even a few points could put you in a lower range of scores and that could affect the interest rate you get on the loan. A higher interest rate means money out of your pocket every month.
In most cases, though, when you’re not seeking a loan, a slight drop in your credit score doesn’t mean much. You’ll quickly make that up if you keep the outstanding balances below 30% on remaining accounts and you make your payments on time.
Despite the temporary drop in your score, it still makes sense to close an unused account, for two reasons. First, it eliminates the temptation to use it if you run into an unexpected financial problem. That’s what your emergency fund is for and you should use that money if the car breaks down or the water heater springs a leak.
The second reason is the plague of identity theft we’re experiencing. If an unused account with available credit is hacked, it will cause you a lot of headaches.
However, you don’t want to close several accounts at once. That would multiply the negative effect on your score. The best way to close multiple unused accounts is gradually, no more than one or two every six months or so. That way you spread out the negative impact, while at the same time minimizing it by keeping low balances and making on-time payments for the accounts you keep.
Bottom line, even though closing an account lowers your score for a time, do it anyway, as long as you’re not in the market for a mortgage or car loan and you don’t close multiple accounts at one time.