Myth #5: Closing credit products like a credit card helps to increase credit score.
Reality: Before I decided to take ownership of my personal finances, I use to think that closing off credit for example credit cards would help to improve my credit score. I mean I thought, well that makes sense because your limiting your access to credit which could potentially lead to debt, why wouldn’t that make you more credit worthy? But I found out years ago that the credit rating system does not work that way.
Deciding to close a credit product like a credit card can actually harm your credit score, especially if it’s an older credit card with good credit history. This is because the credit rating system tracks your credit activity over a rotating 6-7 year cycle with older information being dropped off and newer information being added on. Depending on the lender (for the one’s that do report to the credit bureau), many will update Equifax and TransUnion every 1-3 months on your previous credit activity.
When you decide to voluntarily close a credit product, the lender that will extend you that credit will no longer be reporting to the credit bureau on your credit activity for that product. If the credit card (in this example) you chose to close is one you have had for a long time and have generally a good credit history with, you start to slowly lose that history over time.
If you think of an active credit product as a rotating belt, constantly picking up new credit activity data while dropping off the old ones, it makes perfect sense (sorry I love imagery). The minute the product is closed there is no new information to pick up as the old ones drop off (over a 6-7 year time span). So even if for example you have a credit card for a long period of time and have recently starting missing your monthly minimum payments (which can really negatively affect your credit score), the solution is not to necessarily close that card. Why? Because essentially, your older credit activity (which was really good in this example) would essentially drop off, and your more recent activity before the close (which was the missed payments) would be more magnified for some time until you rebuild your credit.
I know I am oversimplifying it because credit scores require complicated algorithm, but the idea is the same. Understanding it this way for me really helped. I have only had two credit cards at given point in my life, and I only have one currently, but learning this was a real eye opener for me.
Solution: Sometimes reducing access to credit is the best thing to curb spending (I totally get it and I have done it myself), but when you chose which credit product to close, chose wisely. It’s generally best to keep the product that you have held the longest and close the one you recently opened (less than 6 years) because of the whole rotating belt analogy (see above). This is a generally rule of thumb (but I am sure there are exceptions), based on how the credit rating agencies track credit activity.
Tags: a lot of debt, budget, closing a credit card, closing credit, Credit, credit cards, credit report, Debt, debt journey, goals, modest living, myths about credit, net worth, planning, renting, Savings, student debt, student loan, understanding the credit rating system, voluntarily closing credit