Credit card companies are not making it easy on customers these days. Some credit card companies are freezing customer accounts or even closing them outright with little to no advance warning. Other credit card companies are raising interest rates at will – putting customers in a worse financial position than they were before.
This last situation is what I am writing about today. I recently received this reader e-mail:
Q I have been working hard to increase our FICO scores. I am currently in a debt management program and have been excellent in paying for the last year or so. Many of the credit card issuers are increasing their APRs and if you don’t want to accept the new rate you have to decline and they close your account. The credit card companies say it’s for financial viability of the account.
This is what I am writing to you about today. One of our credit cards had a 11% APR and will increase to 18% effective May 1st. There is a balance on this card and I cannot get a balance transfer. And when you close your account it now shows no credit availability which messes up your debt ratios. How do you work on improving your credit score if they put you in a situation where you have to close your account to save your good rate?
Thank you, John.
A Hi John, thanks for sending in your question. Credit card companies are not making it easy on borrowers and it’s too bad you have been caught in the crossfire – especially when you have been working so hard to improve your credit scores.
Ideally, you would be able to take advantage of one of the top 0% balance transfer credit card offers and transfer your current debt to a new credit card at zero percent so you could pay it off more quickly. Since you can’t do that, closing your account may be the best way to save money. As you mentioned, your credit score might take a slight hit if you close your credit card account to avoid the high fees.
Your debt ratio (the amount of credit used vs. the amount of available credit) is only a small portion of your total FICO Credit Score, and your score might not be affected by this as much as you think. But you also need to be aware that closing credit cards accounts can affect your credit score because it changes the average age of credit on your credit report.
I’m going to cover a little bit about how credit scores are determined and how to improve credit scores, and hopefully we can help you find a way to continue improving your credit scores.
How your credit score is determined and how to improve it
How your credit score is determined. As you can see from the following chart, your credit score is composed of several related factors that creditors use to gauge the likelihood they will receive full payment on their loans.
This chart breaks down the components of your FICO score.
The higher your ratings in each of these categories, the higher your overall credit score. It can take a lot of time to make improvements in some of these categories – particularly if you have missed or late payments.
How to improve your credit score. Some people would have you believe there is a magic reset button to increase your credit score. Unfortunately there is not. The only way to improve your credit score is to maintain good credit practices over a period of time. An important thing to note is that the credit score is weighted – different aspects of your credit history affect your score more than others. Focus on improving those areas which are weighted more heavily and you may see improvements to your credit score more quickly.
How to improve your credit score after closing an account
In John’s case, closing a credit account will affect his debt ratio because the card will still have a balance. The debt ratio is part of the “amounts owed” section, which accounts for 30% of the FICO credit score. Increasing your debt ratio will slow down the improvements John is making on his credit score, but as long as he is making on time payments and not adding new debt, the effects should only be temporary.
Closing the account will also affect his average age of credit, which is found in the “length of history” section, which accounts for 15% of the total FICO credit score. However, this change could be positive or negative, depending on how old this credit account is related to the other credit accounts. If it is one of his older accounts, it may decrease his score, and if is a new account and the majority of his cards are older, it may slightly improve that portion of his credit score.
Focus on the big results. As you continue to try and improve your credit score, focus on those actions which will improve your score the most. The most important thing to do is to change your spending habits and stop using your credit cards. You need to stop creating new debt before you can become debt free. Use your debit card or pay cash for your purchases.
After changing your spending habits, you need to focus on those factors which count toward your credit score. The most important item is to continue making on time payments and paying down your current debt to continue lowering your debt ratio. You will also want to avoid opening new lines of credit.
To close or not to close? You may want to consider whether or not closing the credit card account will be worth the hit on your credit score. If you only have a small balance on your card and decide to leave the account open, the increase in your interest rates may not affect your repayment schedule very much and you will not take any hit to your current credit score. On the other hand, if you have a large credit card balance or you don’t need a high credit score right away, then closing the credit card account and temporarily slowing down your progress on improving your credit score might be worth it if it means paying off your total debts more quickly.
Best of luck in your decision.
{ 26 comments… read them below or add one }
I’m curious about something … The letter writer said he is on a debt managent program. Traditionally on a DMP with a credit counseling agency, all of the consumer’s accounts are automatically closed, and the interest rates given to the consumer as part of the DMP concessions are locked in. Is this card with the increasing APR a card that was left off of the program?
Kristen: I don’t know. I posted the question as I received it.
You shouldn’t focus too much on the credit score so much as your credit report. Most agencies will look at the details of your credit report. So when you close accounts you can talk to the person concerned with your score and explain exactly why the score is what it is.
If you can explain your credit report to someone, they will understand you’re at least on top of your money, if not in control of it yet.
I say this because I work at a bank and have spent a lot of time learning more about exactly what your “credit” is.
weakonimist: You’ve got a great point. Credit score is only one part of the equation when getting loans. The main focus should be on making sure everything in your credit report is accurate and as good as can be. Lenders are interested in not only your past (your credit score), but other factors such as your current financial situation, income, debt to income ration, job status, etc.
Great article. And I love the graph.
Thanks, Trevor. I can’t take credit though – it comes directly from the FICO website.
It’s unfortunate that the exact equation for determining credit score isn’t made available. I know it’s probably rather complicated, but it would be nice to know exactly what is necessary to improve your credit score. I recently refinanced my mortgage and took the opportunity to compare the credit score with my past credit score from October when I closed. I increased my credit score 30 points. I didn’t really do anything and I can’t imagine 6 months of on time payments are really that instrumental in effecting my score. Oh well, I suppose I can’t complain if my score went up.
Steve: You’re right – they publish a rough outline of how scores are calculated, but not the entire story. The FICO credit score is proprietary, and if they published it, they would lose out on their entire business model. As it stands there are several companies trying to work their way into the market. As a consumer the best thing one can do is practice good credit usage and maintain a clean credit record.
I just recently had a company that closed an account and it wreaked havoc with a lot of things on my credit report. I was able to get most of it straightened up, but it did cause a dip in my score. It’s true that you shouldn’t worry so much about the score as you should about the credit report, but lenders are still looking at the score. In a lot of places, the score is what is determining the interest rate, and explanation or no, banks will usually follow their guidelines in that respect…particularly underwriters who have no direct contact with the borrower.
Kristy: Your credit score is important for the reasons you mentioned – there are many lenders who use the credit score as a prequalifier, and others that use the credit score as the sole determiner or your interest rate. In many cases, borrowers need to have a clean credit record, and as high a score as they can get. Glad to hear you got your situation worked out.
Good post. Too many people focus on just the credit score. The credit score matters but it is less important than a good financial situation. I believe almost all your focus should be on creating a good financial picture, no credit card debt, spending within your means, create an emergency fund… Your credit score will largely be taken care of that way. And you don’t need to waste much time worrying about a credit card being closed. It does make some sense to pay attention to your credit score – but most people that need to worry about their credit scores would be wise to focus on things like eliminating credit card debt.
Well answered. The other thing to remember is that recent activity counts more than past activity, so the sooner you start credit improvement measures, the quicker you see results.
I am just curious, how long will a closed credit card stay on your credit report?
I wonder how the entire country will manage to keep great scores after so many job losses, forecloures and a deep recession? Last time I requested my fico it showed a 66o just recently conquered the 7 years mark after a BK since 2002. All 3 credit bureaus said Chapter 7 will stay until 2012. I have learned now how to manage credit cards, and mortgage loans. My question is whether FICO will continue to sell the reports stating that “great FICO clients have above XXX scores than yours or similar statements” very soon my report will start showing 700 while many will have less than 500 perhaps the new FICO will say differently based on the current crisis? Like,” great FICO clients have no foreclosures, and have managed to keep current monthly house and credit card payments you are now part of the great FICO clients”….
Definitely enjoyed the article and the subsequent comments! Recently, I received a notice from my VISA card issuer stating they were going to increase my APR from 7% to 18% unless I opted out of this new arrangement. I have not been late with this company and have been with them for approximately 8 years; however, given some of the very unfriendly consumer tactics some of the banks are employing I had great trepidation keeping this account open…even if I opted out of this new arrangement. In other words, I literally have lost faith in their ability to respect me as a cardholder; notwithing “why” would I just give them more money for their coffers. Again, I closed the account and will have to deal with any of its fallout.
what happens to your credit score when the issuing bank closes it’s doors?
I had a big limit on that card with zero balance.. kept it open to keep my score up.
But now that the bank is shutting down.. ????
Linda, I don’t know. Usually banks that close their doors are bought by other financial institutions and the customers never see what happens behind the scenes – the only thing they notice is a new logo on their statements. I don’t know how that affects credit cards accounts though. My recommendation is to contact the bank for more information, but be aware that if there is a transition occurring, they may not have much information to give you because they may not yet know.
Although FICO scores are only a part of the problem, a credit history is very important.
As a new arrival in the country, with cash but no credit history (it is illegal to request credit histories across international boundaries, even for banks), I was forced and fortunate enough to be able to buy my home with cash and a loan from the secondary market.
However, once I was a home owner, I was able to obtain a mortgage from a primary bank and payoff my loan from the secondary market.
Everyone could have saved themselves a lo of trouble and inefficiency by simply looking at my bank account in the first place, rather than the fact that I had no US credit history.
Tony: From what I understand that is a problem that affects people crossing many borders, not just immigrants to the US. For example, I’ve heard it is extremely difficult for new residents to get a bank account in France, much less get access to credit. I’ve never tried though, so I can’t say for certain. It is unfortunate that red tape gets in the way of things like this.
I just got a notice in the mail from Chase on a card i have a 23,900.00 limit and have paid it down to 20,000.00 by paying 500.00 a month. They said they are going up on my minimum payments from 2% to 5%! I cant pay 1000.00 a month! So I called em and they are going to close the account. I have been diligently trying to improve my FICO score from 689 to over 720 to refinance my house. Now, i dont know what this is going to do! It was one of my older cards too, but has been a long time since I used it.
Cyanuk, I don’t know what to say – other than try to continue to negotiate with them. But that may be difficult right now because the credit card companies have been hurting as more and more customers default on their payments. You may mention how long you have been a customer and that closing your account will not only hurt your credit score but lose them a long time customer.
You may also wish to look at zero percent balance transfer credit card offers to save money.
Here is more information about how they work: How to do a 0% Balance Transfer Offer.
I have two credit cards. One with Citibank and one with Chase. I have quit using them and am working with paying them off each has about a $6000 balance. They both sent notices that they were going to raise rates on previous purchases unless I closed the accounts. The rates were going to go from 11% to 23.9%. I own my home and do not plan to use any credit except maybe for a car loan in the next few years. Would it be better to take a hit on my credit score to avoid the higher interest charges and make it easier to pay them off?
Dan, Have you considered a 0% balance transfer credit card offer? With these offers, you can transfer your current debt to a new credit card at zero percent so you could pay it off more quickly. That way you wouldn’t take a hit on your credit score. If you qualify, you can transfer the balance from both cards to a zero percent card and direct all your payments to the one bill. Just be sure not to add to the debt you currently have, and it should work out great.
Just had Bank Of America close my account,this account was never late ,always paid early,how will this effect my credit,does it go on the negotive side,or will it still show paid as agreed.
Mary, As long as you pay your bill, it won’t be negative. The account closure may affect your credit score because your average age of credit will change, as will your amount of available credit. But it is nearly impossible to tell how much it will affect your score.
I was really glad to find this site. The article AND the comments were really, really helpful to me. I bought a home in March 2008 and really hate he neighborhood (even though we rented here for 1 yr before buying), so we are putting the home back on the market and want to rent.
When we bought the home my score was 622, now it is 563. I had some negative past due in Nov 2008 and have closed all three of my credit cards. My total credit debt is only about $1300. I really want to move but I am worried that I won’t be able to find someone who wants to rent to me b/c of my score. I am glad to hear commentors say not to focus so much on the FICO. My sister tried to tell me the same. But in this country we are slaves to that number. I don’t want any loans and frankly I don’t want anymore credit cards and I don’t want to buy another home either.
I just wanted to say thanks for the info. It is a relief to hear someone who works at a bank admit that creditors look at the whole report b/c my trades look good. I have more than 20 positive paid accounts (although most are paid off and not active) for almost a year and only 1 collection for $67 (medical), which I didn’t know I had. My balance on my car loan is only $430.
My DTI (debt to income) is 26, so we are liquid, so I am hoping that is what will be looked at rather than soley the FICO.