Cancelling Credit Card Accounts

When you're trying to get a handle on your debt and improve your score, your first impulse might be to take a scissors to all the cards in your wallet and close down any accounts you're not using.

Associated Press reports that the scissors part is fine, but canceling your cards could actually hurt your credit score. The math nerds at FICO look at a host of factors, but the biggest component is your credit-utilization rate - your total outstanding debt divided by your credit limits.

FICO's research has found that people with lower credit-utilization rates are more likely to pay back debts, making them a better risk for lenders, Watts said.

By closing those unused accounts, inadvertently you raise your utilization rate for those remaining accounts. "The FICO score doesn't know why you closed those accounts, it just knows your utilization rate has gone higher and your score drops. It's an unintended consequence.

You might think that having a bunch of unused accounts with high credit limits would make you look like a greater risk to lenders, because you could just go crazy and max them all out at any moment. But the fact is, most people don't do that. The amount of credit available to a person, by itself, is not predictive of how risky they'll be as a borrower, according to FICO's research.

What's more telling is how people have behaved in the past. That's why it's important to have a good credit history.

(May 3, 2007)