It can be tough to know when to close an account, whether a credit card or loan. This is especially challenging considering you may not know how it affects your credit score.
Closing an account will typically drop your credit score a few points. This comes from two factors. It reduces your available credit, increasing your credit utilization ratio. It may also reduce the length of your credit history, although that is not always the case.
Even with the slight drop to your credit score, it is sometimes worth closing old accounts. Learn more details about how closed accounts affect your credit score and when to leave them open or close them.
How Do Closed Accounts Affect Your Credit Score?
Understanding how your credit score is calculated and how it affects your purchases is a key cornerstone to sound financial knowledge. You will need to have a good credit score to get loans for a car, a home, starting a business, and many other things.
Because your credit score is used for so many financial decisions, it is an excellent idea for you to know what your score is and understand what you can do to keep it in the excellent range. Many factors that weigh into how your score is factored in, and one of the most important of them involves examining your lines of credit. To get an overall understanding of your credit score, you may find yourself wondering what impact closing an account has on your credit score.
Why Did a Closed Account Drop My Credit Score?
There are times you decide to drop a closed account, expecting your credit score to climb, only to be disappointed with a score drop. This may be because closing the credit card reduced the amount of credit available to you.
Closed Accounts Increase Your Credit Utilization Ratio
Some closed accounts will raise your credit utilization rate. This is because closing an account reduces the amount of credit you have available. This is what causes the negative impact. You should note that personal loans such as installment loans do not affect your utilization score. You can safely close your personal accounts without affecting credit utilization rates.
Closed Accounts Decrease Credit History
Another piece of information that is factored into your credit score is your credit history. Many times, closing an account decreases the credit history length. This is determined partially by your combined credit accounts' average age. This means when you close an account, particularly older accounts, you reduce the cards with longer histories. This effectively reduces your average history and impacts your credit score negatively.
It is important to bear in mind that while these two factors can affect your credit score, it doesn't mean they will. If, for example, you have a closed account that had good history but was from nearly a decade ago, the impact won't be that significant.
Is It Good to Have Closed Accounts on Your Credit Report?
If you are considering closing an account, there are a few things you need to consider before closing it. While it may seem like holding fewer cards will help with your credit score, this isn't always the case.
Why Does Closing a Credit Card Affect Your Credit?
We already mentioned that closing your credit card can hurt your credit history and credit utilization ratio. Still, more is to know about this particular impact.
The second most critical factor to your credit score is your balance-to-credit limit ratio or your credit utilization score. The first is your payment history. Higher credit scores have lower credit utilization rates. This score is a measurement of the amount of your available revolving credit you are using at a given time.
Accounts that are closed when there are balances on other credit cards affect your credit score negatively. The closed card will no longer factor into your credit utilization ratio because you can no longer use it. Therefore, allowing a card with a large portion of available credit to stay open can help your credit utilization ratio. In other words, if you are debating about closing a credit card, think about its limit. If it has a very high limit, it may be worth it to keep it open to maintain your low utilization ratio.
The recommended credit utilization ratio by most credit experts is under 30%, and those who have the highest credit scores tend to have a 10% utilization or less.
Should Accounts Be Closed After Paying Them Off?
To get better credit scores, it is generally recommended to leave your cards open when you have paid them off. It is recommended to keep the cards active with small purchases with the balances paid off fully every month.
This is particularly true for those looking to take out a loan in the next few months for a car or a mortgage. Keep your credit history consistent until you complete your transaction.
When Does It Make Sense to Close Your Credit Card?
Even though closing your credit card down when it is paid off can make your score dip, there are some cases where it may be the smart thing to do. If you have multiple credit cards and the one you're considering closing has a yearly fee, it may make more sense to close the card you're paying for.
In instances where someone has struggled with overspending and serious debt, an open card may mean a temptation, so closing it is the best option.
Although it is true scores can dip when you close an account, you tend to see a rebound in a few months. Of course, this is the case assuming that your payments are kept as agreed and the rest of your credit history remains good.
When you decide that closing the account is the direction you're going, contact the lender and ask to close the account. Before you officially close it, verify there are no late fees or charges to take care of. You will also want to see if there are any rewards you could end up losing if you close it. Make sure you use these before you close the account.
If you have any automatic charges set to that card, you will need to contact these companies and make appropriate changes. You don't want to miss one of those payments that were set to automatic and have it negatively affect your credit score. Finally, shred the card and get rid of it.
Does Closing a Bank Account Affect Your Credit?
Your banking information isn't part of credit reports, so closing a savings account or checking account has no impact on your credit history.
However, when your bank accounts get overdrawn and closed with a negative balance, your bank can sell them to collection agencies. The company buying the debt often reports to credit reporting agencies, which causes scores to drop.
Because of this, when you close bank accounts, you need to contact them and make sure everything is cleared, and you don't owe anything. Be sure to cancel any automatic payments and take stock of payments that might not have cleared, just like you would before closing a credit card.
How Long Do Closed Accounts Affect Your Credit?
Closed accounts may not be removed from your credit report right away. This is true of installment loans and credit cards. Closed accounts will stay for a varying length of time, depending on whether they had a negative or positive history. An account in good standing and on-time payment history may remain on your report for 10 years. This helps your credit score.
Those accounts that can negatively impact your report will only stay on for seven years.
When Do You Remove a Closed Account From Your Report?
There are many who have read this far that are now wondering when is a good time to remove these closed accounts from their credit history.
Usually, you want to remove closed accounts from credit reports when what is reported is negative information. This is also true if the details reported are incorrect.
There are a few options you will have for getting this information removed. A formal dispute is the most common method when the information is inaccurate.
If there are inaccuracies, you can dispute this information on your credit report, according to the Consumer Financial Protection Bureau.
You can go online and dispute inaccurate details. Simply provide your address, name, and phone number, as well as the details of the dispute. Some of these will include:
- Written explanation of what the wrong information is and why it is wrong
- Documents proving validity such as payment receipts, cashed checks, etc.
- Copy of credit report with wrong information circled
- Account numbers of disputed accounts
Gather this information and send it to the credit bureau that has the wrong information, as well as the reporting company. Credit reporting agencies are bound by law to investigate, generally within a month, and notify you of their findings.
Closing a credit account is likely to temporarily drop your credit score. Part of this is because of the increase in your credit utilization ratio when you have less credit available. The closed account may also decrease your credit history, which is another factor affecting your credit score. Even so, it frequently makes sense to close old accounts, especially if you already have a long credit history and are concerned about overspending with your line of credit.
Additional reading: Canceling A Credit Card: Does It Affect Your Credit Score?
Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.