Continuing The Credit Building Discussion: Cancel Cards Or Not?

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In response to my two recent posts on building credit (getting credit without a credit card and building up credit), Konstantin writes in and says:

I am following your blog daily and I found two conflicting ideas you suggest that I have a hard time reconciling them:

“Another tip is that by canceling credit cards, you’re actually hurting yourself in two ways. First, you’re reducing the total available revolving credit that you have without reducing the amount of current debt you have, thus raising your credit ratio. Second, by eliminating lines of credit, you’re shortening your credit history. Simply put, if you’ve already got a credit card and paid it off, don’t cancel it; put it away somewhere safe.”

VS.

“Keep the total amount of your credit cards’ available credit low”

So, if I cancel a card and/or if I have several cards – it’s bad BUT if I have several cards the combined credit limit reduces my debt ratio.

What’s the right way then?

These things are only in conflict if you carry a significant balance on your credit cards. Here’s what the game plan should be if you want to get your credit in good shape.

First, pay off all of your balances. Get those cards paid off, whatever it takes. Credit card debt is not healthy debt – the sooner you get rid of it, the better.

Once you’re on this level playing field, cancel some of your cards. I recommend keeping your oldest card and the one with the best bonus program and eliminating all of the rest, including the store-based cards. Why? A large total credit limit can be detrimental because it indicates to lenders that you have the potential to very quickly go deeply into credit card debt.

Once you’re there, use the bonus card, but try to keep the monthly balance under 20% of your total credit limit. For example, if the total limit on your remaining cards is $20,000, don’t carry more than $4,000 on the card if at all possible.

Doing this will keep the total amount of available credit low while not hurting you for eliminating lines of credit and altering your debt-to-credit ratio. The end result? A much better credit rating.

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26 thoughts on “Continuing The Credit Building Discussion: Cancel Cards Or Not?

  1. I have only two cards. I have $2,000 on one of them and nothing on the other. But they keep raising my available credit: last time I looked I think I had a 16k limit on one and 17k on the other. 33k ready and waiting for me! (ha)

    That seems crazy, excessive, and even dangerous in the wrong hands.. would it be a bad idea to lower the available credit?

    both banks are highly reputable, and I’m not worried that I will charge them up, so I could leave them alone, but… 33k available seems nutty. Thoughts?

  2. I heartily recommend the DVD “Maxed Out” for an interesting education on the credit industry. There is not perfect way, but there is a more educated way to deal with a mostly parastic industry.

  3. Do creditors really care about total credit limit, as opposed to how much of it is used?

    The experience of those who do 0% balance transfers as a way to make money seems to suggest otherwise. Those that exceed a certain percentage of credit used run into trouble, but those who stay under seem to do fine.

    (Though I wonder how the “App-o-Rama” folks are doing now that we’re seeing a credit crunch.)

  4. Another thing to consider when pairing down your cards is getting cards on different networks. For example, a Master Card and an American Express card are going to give you a better chance of using your card in an emergency than two Visas from the same bank.

    This is especially true if you are traveling internationally. I’ve run into weird issues where one card wouldn’t work, but the other would and the credit card company couldn’t explain why their card was rejected.

  5. I have tried very hard to live without credit cards. The thing is that I simply do not have quite enough income to make it from paycheck to paycheck. (And please don’t tell me there are ways I can cut back. I have no running water, electricites and very minimal utilites. I would be okay if I didn’t have to drive to work!) Anyway, I am getting killed by overdrafts. It seemed to me that I could use a credit card to get through those four days or so and have enough to pay it off plus interest. I don’t know if I’m right or not. I sure would prefer to have a better paying job.

  6. @Teri: Wow, no running water or electricity sounds horrible- where do you live? Can you live closer to work, to save money on driving? Is there anything you can do to get a better-paying job? If you can get through the month without a credit card, you can stop paying overdraft fees and debts, and your cost of living will go down.

  7. In fact, banks will look at your available credit when you apply for new credit. The reasoning is the following: what is your point of asking for more credit when you already have 40K available?

    I personally use 3 credit cards: Visa, Master Card and Amex. Then, I am sure that they take one of my credit card wherever I go, that my limit is high enough to not affect my debt-to-credit-ration and the most important part, I pay the full bill on all my card at the end of the month.

    Then, you will build a strong credit history, get reward point from your credit cards and not pay interest on top of it!

  8. Thank you, Trent for following up on my question!
    Yes, with this explanation it all makes sense.

  9. Great timing for me with this article. I opened up a Macy’s card to get the store discount. But the interest rate on that card is 19.99%. I have other cards which have better interest rates. I plan to cancel this card.

    Will opening cards like this (to get store discount etc.) ruin the credit score? They have to check my credit history background anyway. It looks like it is not a great idea to do such things to improve the credit score. Trent, any input (for future article) on this?

  10. Trent: “A large total credit limit can be detrimental because it indicates to lenders that you have the potential to very quickly go deeply into credit card debt.” – this is bit debatable. It used to be the thinking in the past. As far as I know (unfortunately, I don’t have any single specific reference here), now-a-days, mortgage lenders don’t worry about high credit limits, they are more interested in your credit score [in the past, mortgage lenders were the only people who were worried about people having high credit limits - it didn't matter to anyone else].

    For all other events which require good credit (credit cards applications, car loans, educational loans, etc.) it doesn’t really matter what your credit limit is as long as you have a good credit score.

    In light of this, not canceling credit cards will make sense.

    If anyone has factual data which negates my current perception, I will be happy to follow it up.

  11. im not sure on what to do.. i only use two cards.. a retail card which i make a payment monthly at 0% int. and a freq. flier earning card i pay off every month. BUT i came for college from another country 5 years ago. i had no credit so i started with retail cards… lots, around 10 or 12…. all but one paid off… should i camcel these??????? do i camcel the ones with low limits or ones with higher interest or none at all??? doesnt canceling a credit card HURT your FICO score??? confused. please help!

  12. There are non-denomination churches out there with active finance ministries who will not “trip” and they won’t ask a thing of you. The not for profit money agencies have somewhat dry conversations about budget, goals, etc.

    Economics is mostly a numbers game, but even Einstein couldn’t understand parts of it. Posts like Teri’s make me think that while credit is neutral, the feeling in your soul that there is not “enough” is a rough place to be. And, a lie. Not trying to spiritualize, but Teri is on the cusp of something.

  13. I completely disagree with this advice. It actually hurts your FICO score to close a credit card or reduce your credit line. So from the perspective of optimizing your score alone, the thing to do is get huge credit lines…and not use them. Now, there is some evidence that human reviewers may not like seeing those huge credit lines. But I will assume it’s not a problem until someone actually turns me down for credit and tells me that’s the reason (I have nearly an 800 FICO score). If that actually happened to me (as in not a theoretical thing anymore) I might consider reducing some of my lines, since it’s extremely simple to do so (much easier than getting your lines increased). Also, keep in mind that what constitutes a “huge” credit line may be more than you think. Many people have 5-10x more unused credit card lines than income. I’d be willing to bet that this situation is now so common that the banks don’t even blink at it anymore when looking at mortgages, etc…because it has probably lost most of its predictive value in spotting people who are in danger of getting overloaded on debt.

  14. For the millionth time: a $2000 credit card with a $0 balance (ie $2000 cash “remaining”) is a $2000 LIABILITY. It is NOT an asset.

    It goes in the red column against your name.

    I just got a $5000 bonus (of which I earnt every last cent, TYVM :) ) which I used for nothing else other than cancelling one $3000 c/c and bringing another $2000 to a $0 balance. I can’t think of a better way that I could have used that $5000 to support and provide for my family.

    (When I called up the bank to cancel the card the polite young man asked me why I was cancelling the card and I said that I didn’t want the credit against my name. He then reminded me that I had paid the fees up until next April, would I like to hold onto the card until then? I told him that I don’t want the credit against my name. He offered to put me onto a low-rate c/c and I told him that I don’t want the credit against my name. He then asked me if I really wanted to cancel the card and I told him for a fourth time that I didn’t want the credit against my name and he finally put me on hold to, presumably, go ask his boss how to ACTUALLY cancel a card.)

  15. To build the credit score, is it good to pay off the credit balance in full or spread it over a few months (i.e. paying minimum+ amount)? I hate to have credit balance but at the same time I hate to dip into my emergency funds too. Any advice?

  16. brent:
    You’re simply factually wrong. It doesn’t count against you, as far as the FICO scoring model. It DOES count against you if you were carrying a balance, which it sounds like you were.

  17. Kleanchap – it’s better to pay your balance in full. Then your ratio of your debt to available credit is low since your debt is low. Always pay your balance in full unless taking advantage of 0% offers.

  18. Well, there are couple or more issues with the topic you have brought up and how FICO looks at it. I will try to keep my comments as short as possible but this is a somewhat complicated topic.

    First, let’s look at the way FICO computes a score. Payment History 35%, Amount Owed (Capacity) 30%, Length of Credit History 15%, Types of Credit 10% and New Credit 10%.

    So aside from Payment History, the balances you carry in relation to the amount of potential debt available or “Capacity” is the second most important factor. I saw where you said 20% of the available credit as a balance is good and I agree, although 30% will work just as well. The issue is not to exceed either. A credit score is used primarily to determine who will go 90 days late on their payments and who will over extend their credit limitis.

    So, using the FICO model for calculating scores, the Length of Credit History becomes the third most important factor. Any account that has some age and either a small or zero balance will count as a positive for you. When people ask, I personally don’t recommend ever closing an account for this reason.

    Now, to rebuild credit and/or add points to your scores via a legitimate vehicle that is very cost effective, I recommend using secured loans from credit unions to establish new credit (10%)which charge a minimum of interest for a six month loan (often $5 to $8 for a $500 amount), will automatically draft from a secured account like a savings account, to show a sound payment history (35%) and then will show a pay off after six months which reflects possitively on the amount of credit owed (30%).

    So, by using this technique and by working with the credit you already have, you can effectively raise your credit scores 100 to 200 points over a twelve month period if you are persistent because there is nothing to keep you from taking out a loan every pay day. By taking out joint loans like this, my wife and I were able to add “12″ loans to her and my credit files by taking out six loans each. All of this is perfectly legal, cost effective and added over 120 points to our credit scores as each loan, when paid off adds 10 to 20 points to your score by addressing the components of scoring previously noted.

    Regarding paying out your balance over a period of time, it is, in fact, better to pay off the balance incrementally. That is not to say it will hurt you to pay off the balance each month. What does hurt is to carry a large balance for some time and then pay it all off at once. The scoring model looks for consistent payments (payment history) which reduces the balance (read capacity) but allows interest to be made. I have a friend that had $100,000 in credit card debt which he carried for a year or two. He sold a piece of real estate he owned and paid off all the debt at once. His scores went down to his amazement. The FICO mathimatical model looks for consistency above all else because that is the safest customer to predict a positive result,i.e. profit.

    Paying off with a “big hit” doesn’t fit the profile of a “perfect” customer for FICO and the lenders.

    Hope this helps.

  19. By the way, I forgot to add FICO works best if you have five credit cards and other sources of credit such as car, home and bank loans. If there is no diversification of your types of credit it will work against you. I, personally, was stunned to learn that five cards is considered good, but according to FICO, it is.

  20. 5 cards? good or not I will NEVER have more than one credit card again, and that one is a credit union card with a high limit and very low APR.

  21. A few years ago I cancelled my longest-held credit card because I had memorized the number and it was far too easy to spend online! I did open a different card with the bank at the same time, but switched from visa to mastercard (for some reason that made sense then).

    Any guesses whether that hurt my score? Last I checked my score was fine and I’m not getting a mortgage anytime soon, so it’s mainly a question asked out of curiosity.

    (Yes, five years later I still remember that cc number. I also have memorized two library card numbers!)

  22. @kleanchap: check out myfico.com’s consumer education or forums for answers to your questions. There are a lot of myths and misconceptions regarding credit, and it’s best to do some homework and find info from more than one source.

    Also, applying for new cards for a store discount will hurt your credit score. Both the credit inquiry and having an account less than six months old have a large negative impact. Even cards less than two years old have a negative impact. Only apply for credit when you need it.

  23. I have to reiterate what several others have said above: this is bad advice. Do not close your accounts, do not lower your credit limits. In the current credit market, FICO is all that matters, and FICO penalizes you for having a higher debt ratio (i.e. a lower aggregate credit limit). I have yet to see or hear anything concrete to support the advice you have given. Maybe a banker in a manual underwriting situation (i.e. when your FICO sucks) would care. But even in such a situation, I think that you could make a strong argument that having $$$ in available credit but not having used it contributes to your positive creditworthiness in general. You are able to resist temptation.

    Can you give me any proof of your assertion? A quote from your banker? Something from Fair Isaac, or anywhere else?

  24. You have mentioned that not to cancel an old credit card for several reasons. But how about cancel a credit card with just 9 month history, $100 credit limit with two late payment history. Will it remove all the record of that credit card including the late payment history?

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