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 cards 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. The good news is that you don’t need a credit card to build credit. You can repair your credit by reporting mortgage payments, rental payments, and other installment loans to credit bureaus. 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.
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.