You may be tempted by dazzling offers to add another credit card to your wallet…and another…and another. But can adding too many—or canceling some of the cards you already have—ding your credit score? That’s important to know because if you want to get a mortgage, a home-equity loan or a car loan, and get it on very attractive terms, you need a stellar credit score—perhaps 750 or higher for the best terms. To achieve and/or retain that high a score, it helps to know how to avoid missteps, which is not always easy in the face of conflicting, shifting and confusing guidelines. We asked credit expert John Ulzheimer how to maneuver through the credit card maze…
• Is it better to have many credit cards or just a few? The more credit cards that you have, the bigger your combined overall credit limit is likely to be. That’s because the system developed by the company Fair Isaac, whose FICO credit-scoring method is the industry standard, considers how much of your available credit you are using at any time. That percentage—called the revolving utilization ratio—is a major component of a factor called indebtedness, which makes up 30% of your total score. The lower your overall credit limit, the more each dollar you charge can increase this ratio—and decrease your credit score—even if you pay off your balances in full at the end of each billing cycle. For the purpose of calculating the utilization ratio, it doesn’t matter whether your charges are on one card or spread over several.
• Does that mean I should avoid canceling credit cards? Generally, yes. If you cancel a credit card, your utilization ratio will rise and your credit score can drop—unless you either replace the card with a new one that has the same or a greater credit limit…or reduce the balance that you have on your remaining cards.
Important: It’s an especially bad idea to cancel high-limit cards shortly before applying for a loan. And because new credit inquiries could temporarily lower your score, applying for new cards shortly before applying for a loan is a bad idea, too.
• If I am planning to cancel a card, should I pay off my outstanding balance on that card first to avoid hurting my score? Yes. When you cancel a card before the full balance is paid off, the card’s credit limit is replaced by its highest-ever balance—the most you have ever had charged on the card—when calculating your utilization ratio. If that balance is well below the card’s credit limit, canceling would slash your credit limit while you still have debt, resulting in a higher-than-necessary utilization ratio. It’s much better to put off canceling until the balance is paid off.
• Can you have too many credit cards? Not really. Having lots of credit cards is good for your score because it increases your overall credit limit and so lowers your utilization ratio. It shouldn’t reduce your odds of qualifying for additional cards, either. Most card issuers offer particularly attractive deals to consumers who already have several cards. That’s meant to encourage these consumers to put the issuer’s card on the top in an already crowded wallet. However, having balances on three or more cards at the same time can hurt your score, even if you pay off those balances each month.
The major risks of having open but unused accounts are that a criminal could get hold of one or more accounts and make fraudulent charges…and that the cardholder might lack the self-control to avoid accruing debt on every available card. To reduce these risks, you can destroy the card itself without canceling the account.
• How do cards that have no preset credit limits affect a cardholder’s utilization ratio? Fair Isaac’s treatment of no-limit cards, such as certain American Express cards, is changing. In the newest FICO scoring system—FICO 8—no-limit cards do not count toward the overall credit limit in determining the utilization ratio, so closing them has very little effect on your credit score.
In earlier FICO scoring systems, however, the highest balance that the cardholder ever reached on a card was treated as that card’s credit limit for the purposes of determining credit utilization. Under those systems, canceling a no-limit charge card on which you previously ran up a big balance could significantly have increased your utilization ratio, thus lowering your credit score. Certain lenders—mortgage lenders Fannie Mae and Freddie Mac among them—continue to use these older scoring systems.
• How do store-issued credit cards affect my score? It is helpful to have both store cards and bank-issued cards in your credit history—this credit mix improves the diversity of your credit usage, which makes up 10% of your credit score. Store cards tend to have low credit limits, so canceling them generally has limited impact on your utilization ratio.
Certain store cards should be avoided, however. The store cards offered by major department stores and home-supply stores, such as The Home Depot and Lowe’s, typically are issued by banking companies and have no downside from a credit-scoring perspective. But those provided by some other big-box retailers, including major appliance, electronics and furniture stores, often are issued by consumer finance companies. These companies tend to serve high-risk borrowers, so the presence of finance-company accounts in your credit history may lower your credit score.
• Is it true that canceling your oldest credit card can hurt your score even if you replace it with a new card? That’s only partly true. The age of your overall credit history does play a role in your credit score. Fair Isaac calls this Time in File, and it’s worth 15% of your overall score. But canceling your oldest card will not reduce the points that you earn from Time in File anytime soon—canceled cards remain in your credit history for at least another decade.
In theory, closing your oldest credit account—whether that’s a bank-issued card, a store-issued card, a mortgage, a student loan or a personal loan—could hurt your credit score 10 years or more from now, but even that’s unlikely. Once your credit history reaches a certain age—Fair Isaac does not disclose exactly what age, but it’s probably around 20 years—you max out the points that you can earn from the Time in File portion of your credit history.
So as long as you have another credit card (or other credit account) that is at least 10 years old when you cancel your oldest card, you’ll have one that’s at least 20 years old when that canceled card eventually drops off your credit history in 10 years, and so you will continue to max out your Time in File points.
Caveat: A portion of your Time in File points—again, Fair Isaac doesn’t disclose exactly how much—comes not from the age of your oldest credit account but from the average age of all of the accounts in your credit history. If your oldest credit account is much older than all your other accounts, it probably is worth keeping it open.
Bottom Line/Personal interviewed John Ulzheimer, president of consumer education for SmartCredit.com, based in Costa Mesa, California. He formerly worked with credit-score developer Fair Isaac and credit-reporting agency Equifax.