Should You Keep Old Unused Credit Card Accounts Open?
The age-old question about whether to keep old, unused credit card accounts open has puzzled many a consumer. The FICO Credit Scoring System, which is the be-all, end-all for credit scores, holds the key to understanding why keeping such accounts open can be advantageous. Understanding the components of the FICO credit score, particularly payment history and credit utilization, can help you make a well-informed decision.
Understanding FICO and Payment History
The FICO Credit Scoring System evaluates various aspects of your credit history to determine your creditworthiness. A crucial component of this score is your payment history, which makes up about 35% of your total score. FICO considers this because payment history directly reflects your ability to manage credit responsibly. Once a credit card account is no longer used for over 24 months, FICO typically removes it from your credit report. This is because the account doesn't have any recent activity to be scored. However, the longer the account remains open, the better it is for your credit score over time.
Impact on Credit Utilization
A significant factor in your FICO score is your credit utilization ratio, which accounts for about 30% of your score. This ratio is the amount of credit you are using compared to your total credit limit. Keeping old, unused credit cards open can decrease your credit utilization ratio, as lenders do not consider the maximum credit limit on inactive accounts when evaluating your borrowing capacity. Therefore, maintaining these accounts can help keep your utilization ratio low, which in turn boosts your credit score.
Contractual Obligations and Fees
While keeping old credit card accounts open can be beneficial, there are considerations to keep in mind. If you are paying an annual fee for a card, it might be worth transferring to a no-fee card with the same issuer. For instance, if you had a job that required travel and you paid a yearly fee for an airline card, you might have closed it when you left the job. However, retaining the card could have helped keep your credit utilization ratio lower.
Impact on Future Borrowing
When applying for a loan or credit, lenders consider your total debt, including the maximum limits on all credit cards. Keeping old, unused credit card accounts can reduce the amount that a lender is willing to offer you. This is because the maximum credit limit on open cards is considered current debt, which in turn reduces the available credit. Therefore, closing these accounts can limit your borrowing capacity.
Cancellation and Early Exit Procedures
While it's generally recommended to keep old credit card accounts open, early cancellation can have negative consequences. Most credit cards come with terms and conditions. Reading the fine print can help you determine whether it is safe to cancel a card. If you do decide to cancel, it's crucial to understand the impact it could have on your credit score and credit utilization ratio.
Closing Accounts and Their Impact
When you close old credit card accounts, your credit score can drop. This is because fewer open credit accounts can affect your credit utilization ratio. Even closed credit cards can still impact your credit score, especially when considering credit utilization. As a general rule, it's advisable to use the cards at least once every 6 months to keep them active.
Conclusion
Deciding whether to keep old, unused credit card accounts open or not requires a thorough understanding of how FICO credit scores and other credit-related factors work. Keeping your payment history strong and maintaining a low credit utilization ratio are crucial for a good credit score. Additionally, understanding the terms and conditions of your credit cards can help you make informed decisions and avoid potential pitfalls.