By Jed Collins, CFP®
Sarah is 25 and trying to get her personal finances in order. First thing on her list is getting her credit situation in control, and she finds herself looking at her two credit cards. One is a retail card that she got on her 18th birthday from her favorite store, Target. The other is an everyday Amex card that she got after college.
By now Sarah understands that she must pay her balance every month, on time, to avoid the credit trap. But now she wants to simplify her spending and increase her credit score, so she begins to dial the phone to cancel that old credit card from Target.
WAIT! Before you cancel that old credit card, consider how it will impact your FICO score:
30% of FICO score = Debt owed to credit limit available
Each of Sarah’s credit cards has a limit of $5,000. Sarah puts roughly $500 on her Target credit card and another $1,000 on her Amex card every month. She’s currently using $1,500 of debt compared to a $10,000 credit limit giving her a 15 percent usage.
Sarah wants to stop using the Target card and stop spending the extra $500, so she cancels it. Now Sarah is using $1,000 a month of her $5,000 credit limit; which gives her a higher usage of 20% and negatively impacts her Fico Score.
Simply put, canceling your old credit card, even though you don’t want to use it, will decrease your total credit limit available. Now, even though you are being more frugal and spending less, the ratio of how much you owe (debt) to how much you have available (credit) is still not in your favor.
Expert tip: Try to maintain your current debt (usage) of credit available below 30 percent.
15% of FICO score = Length of credit history
It takes a lifetime to build a credit reputation. Credit companies want to see how long you have been making payments, building up your credit, and being responsible. In their eyes, if you cancel the older of the two credit cards, your reputation has been cut from seven years down to only three—reducing the length of credit history and negatively impacting your FICO score.
Looking at how often and where you use the Amex card, it is easy to see the everyday credit card is more practical to keep. But the second reason you don’t want to cancel that old Target card is that you got it on your 18th birthday, four years before the Amex card.
10% of FICO score = Mix of loan and card types
Congratulations! You got a promotion to manager. You are now responsible for making sure not only your job is completed, but also Todd’s job as well. If you can prove you can handle the responsibility of two people’s production, you will be allowed to take on more and more responsibility in the future.
The job analogy reflects the view of a credit company into how they score you. If you can prove you can handle your job and complete all your tasks on time, you will be rewarded with a positive score. If you can prove that you are also capable of handling different types of jobs and different types of responsibility, then you will be rewarded even more.
The credit company wants to see that you are responsible enough to manage more than one type of debt. Down the road, you will get points for having an auto loan or a home mortgage. For now, holding onto the two credit cards and proving you can handle the responsibility of different lines of credit and different payment dates will have a positive impact on your FICO score.
When would I call to cancel my old credit card? If your old card has some sort of annual fee attached to it, there is no need to pay $50 for a few points in your FICO score.
What is the best plan of action? Go into the drawer, get out a pair of scissors, and cut up your old credit card. This way you won’t be tempted to use it, but you will maintain all the positive effects on your FICO score mentioned. Then when you do want to use the credit card again, you simply call and get a new card mailed.
- Take out the credit cards in your wallet and compare
- Ask: Which has the longest history, which have fees attached, and which do I see myself using going forward?
- Go get some scissors!
Do you have specific questions? We’re here to help! Reach out to us today.
Jed Collins serves as a relationship manager at Brighton Jones.
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