Have you thought about canceling a credit card that is collecting dust in your dresser drawer? Or one that has been used so often you have the card number memorized? While closing a card sometimes makes sense, other times, it may do more harm than good. The following are some factors that are helpful to consider when deciding whether to cancel a credit card:

  • Cost: What will it cost you to keep the account open? Having a high interest rate does not necessarily matter because closing the account will not lower the interest rate on an existing balance (and you are not charged any interest if you pay off your balance in full each month). But if you are charged an annual fee, that is certainly relevant. Finding a card without this fee may be difficult if you are new to credit or have a blemished credit history. There are also some cards that charge an annual fee but provide special perks, such as a generous reward program or enhanced customer service. However, if you have a good credit history and the card does not come with any extras, it may not make sense to keep a card that charges an annual fee, especially if you have not had it for long.
  • Ability to use credit without getting into debt: If you have struggled to control your spending in the past, consider whether there are ways you can avoid overusing your card short of canceling it. For example, can you leave it at home most of the time and only take it out once a month to buy a pack of gum or something else cheap? (You could keep also just keep the account open and not use the card, but by doing this, you do not continue to build a positive payment history and also risk the account being closed by the creditor due to inactivity.) Honestly assess your capabilities and limitations.
  • Effect on credit score: 35% of your FICO credit score is based on your payment history. Closing an account does not have an immediate effect on this factor, since positive information for closed accounts typically stays on your credit report for ten years (seven for negative). However, if you do not have other accounts that you are making payments on, over time, your score may suffer due to not having a recent positive payment history. Additionally, if you close your oldest account, when it falls of your report, that will shorten the length of your credit history, which makes up 15% of your credit score (the longer the length the better).

Depending on how much you owe, closing an account can have a significant impact on the factor that considers your credit utilization ratio (balances owed/credit limits), which accounts for 30% of your credit score. To have a good score, it is best to have a credit utilization ratio under 50%. If you have multiple accounts and the balances relative to the credit limits are low, then closing one account with a low credit limit probably won’t have much of an effect. Conversely, if you have high balances, closing an account with a decent credit line can cause your score to plunge.

  • Importance of having a good credit score: If you expect that closing the credit card will negatively impact your credit score, consider if having a good credit score is necessary right now. If you are applying for a mortgage, apartment, or car loan in the next several months, it probably is. If you do not plan to get credit soon and feel that the only way to stay debt free is to close your cards, canceling may be the best option, even if your credit score will suffer.

If you ultimately decide to cancel a card, you should send a request to the creditor via certified mail and keep a copy of the letter for your records. Follow up with the creditor a few weeks later to confirm the account is closed, and check your credit report to make sure the account status is being correctly reported. (You can get a free copy of your credit report from each of the three credit bureaus once a year from www.annualcreditreport.com.) If it is not, you can notify the creditor as well as dispute the incorrect information with the credit bureau.

1. Save your credit card receipts, and compare them to your monthly bill when you receive it. Contact your creditor right away if you notice any discrepancies.

2. If you are experiencing financial difficulties and are unable to pay your bills, call your creditors and service providers. They cannot help you if you don’t talk to them.

3. Think carefully before you agree to be a co-signer on a loan or credit card. If the primary borrower does not pay, you can be held responsible for the full balance.

4. Read the fine print. Yes, it may be boring, but knowing how your account operates will help you avoid trouble down the road.

5. If you are traveling out of the country, notify your creditors ahead of time. Otherwise, if they see foreign charges, they may think your account was stolen and freeze it.

6. Stick with only one or two store cards. You may be tempted to apply to get a discount, but having too many accounts can hurt your credit score. And it may be difficult to remember all of the due dates!

7. If you pay extra one month, remember that you still have to make the minimum payment the next month. Paying extra does not allow you to skip a payment.

8. If you receive a phone call or e-mail from your creditor, call them back at a verified number (look at your statement or card), not the one in the message. Many identity thieves steal information by posing as legitimate companies.

9. Draw a line through any blank spaces on receipts to prevent a charge from being added later.

10. When entering your PIN on the keypad in a store, be careful. Cover the keypad with your hand, and if anyone is standing uncomfortably close to you, don’t be afraid to ask him or her to move back.

Your Credit Score, Your Money & What's at Stake (Updated Edition): How to Improve the 3-Digit Number that Shapes Your Financial Future
By Liz Pulliam Weston (FT Press 2009)

Liz Pulliam Weston’s updated book is a great guide on how you can achieve a credit score that is an asset, not a liability. The book describes in detail the factors that determine your FICO score, including the changes made under FICO 08, the new version of the scoring system. As the title implies, it also discusses what you can do to improve your credit score. The information on how to read your credit report and dispute errors (which, depending on what they are, may be bringing down your score) is especially invaluable. Other topics covered include debt repayment, identity theft, rapid rescoring, and insurance scores. If looking at your credit report makes you frown and wonder “What can I do?” this is the book for you.

Copyright © 2010 BALANCE
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