Sunday, September 20, 2009

I cancelled my credit cards. Will it hurt my credit score?

I'm staring off the week with some of the great questions I got my new Twitter followers (thanks to @jemelehill):
I paid off and canceled my two credit cards about seven months ago. I don't want to get another one. My friend's mom told me I need to have at least one credit card and use it regularly to build credit. She made it sound like I was actually messing myself up as if nothing else mattered. Is it really that big of a deal? I don't want another credit card.

Yes, it really is that big a deal for three reasons:

1) The ratio of your available credit to your actual debt is a huge factor in your credit score. Once you close a card, you immediately lose the available credit part of that equation. Follow me here:

I have two cards with $10,000 limits and I'm carrying a $2,500 balance on one of them. I'm using just over 10 percent of my available credit of $20,000. That's excellent because the credit bureaus and lenders like to see that you're using as little as possible of your available credit. It's supposedly a sign that you're not overextending yourself.

If I close one of the cards, I have the same $2,500 debt but with available credit of only $10,000. That's a ratio of 25 percent of your available credit. In other words, it looks to the credit bureaus like I'm suddenly borrowing more than twice what I was just a month before.My score takes a hit.

2) Also, since the length of your credit history is a factor in your credit score, closing both your credit card accounts hurts because it erases any good credit history you've built up by using those cards responsibly. If you had those two cards for 10 years and a car note from a year ago, suddenly your the oldest active account you have is a year ago, not 10 years old.

3) You really can't afford to not have a card unless you're wealthy enough to be certain that you can pay for any and every expense that comes up in cash, all the time. You need it for basics like getting a plane ticket or renting a car. True you could use a bank debit card, but some companies will charge you a fee to use a debit card instead of a credit card. And of course, there's always emergencies.

Thanks for the question and good luck.

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