Don't close accounts after paying card debt
Dear Credit Smart,
I’m refinancing my house with a cash-out option, meaning that I will be paying off most of my credit cards. The mortgage company wants me to contact each credit card account and tell them that I will be closing my account with them per my refinance. My question is: will closing these accounts hurt my credit score for future purchases, such as a new vehicle? – Tom
It sounds like your mortgage company is behind the times. While paying off credit cards and closing accounts was the practice in years past, scoring models have changed and the information you received is outdated.
Today’s models still do like paying off credit card debt; they just don’t like to see closed accounts. This is because closing accounts reduces your available credit, which is an important component of credit scoring. The more credit you have available, the better it is for your credit score.
In your case, it sounds like you are hoping to purchase a new vehicle in the not-so-near future. This is a great reason for wanting your credit score to be in the best possible shape. Your credit score have a big impact on the rate you get on an auto loan. A difference of even a percentage point or two on that loan can make a big difference in your car payment and what you will ultimately end up paying.
You will certainly want to pay off your credit card debt in full with your cash-out, but leave those accounts open. To prevent the credit card companies from closing the accounts on their own, you will probably need to continue to use them on a fairly regular basis.
This does not mean I want you to accumulate credit card debt again. What I want you to do is use your cards for small purchases you would have made anyway, for which you have the cash available to pay at the time of purchase. Then when you get your credit card statement, pay your balance in full, on time, with the money you have set aside at the time of the purchase. This is a great practice for keeping your credit in shape – not to mention being the best practice for your overall financial health.
Please notice that I said use your cards for small purchases. Your credit utilization rate is one of the most important factors in credit scoring, so the less you use, the better. Simply put, if you have a credit card with a $2,000 limit and you charge $1,900 in the month it will hurt your score. This is true even though you will pay the $1,900 in full when the bill is due. A better use of that card would be to spend $50 or $100 and still pay it off in full when due.
FICO, the company that provides the most widely used credit score, agrees that you do not need to close your card accounts. It says plainly, “We never recommend closing a credit card for the sole purpose of raising your FICO score.”
Remember to always use your credit smarts!
See related: How closing card accounts affect your credit score
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