Barry Paperno is a freelance writer and credit scoring expert with decades of consumer credit industry experience, serving as consumer affairs manager for FICO (formerly Fair Isaac Corp.) and consumer operations manager for Experian. He writes “Speaking of Credit,” a weekly reader Q&A column about credit scoring and rebuilding credit, for CreditCards.com. His writings about credit scoring have appeared in The Huffington Post, MSN Money, CBS Money Watch and other consumer finance websites.
Dear Speaking of Credit,
I want to get a credit card that has 0 percent interest for the first 15 months to make a one-time purchase for about $2,500. I will pay off the amount in the 15 months, and then I want to close the account. I want to close the account for convenience, I have two cards already. Will this negatively affect my credit score? — Ben
You can’t beat 0 percent interest. While it’s hard to argue against free money, your question shows you have a sense there could be some negative impact to your credit score if you charge $2,500 on a new card offering 0 percent interest for 15 months and close it after paying the balance in full within that time.
Also, you may have some idea of the underlying reason for this concern, which is that closing a card can, in some cases, raise the combined account utilization percentage of all your cards (total balances divided by total credit limits) by removing from the scoring equation the closed card’s credit limit amount and zero balance.
But before talking about what happens after paying off and closing a card, let’s first talk about the score drop of roughly 10-45 points you could experience as soon as that new account is added to your credit report with a maxed out or otherwise high balance — a strong possibility if you’re only given a credit limit of $2,500 or so.
Even if you don’t come anywhere near maxing out the card, you still could see a lower score due to a couple of other less-weighty factors: Reduction of your “average age of accounts” (total number of months for all accounts divided by the number of accounts), when the new account first appears on your credit report, and the increased number of “hard” inquiries, once your credit score has been accessed as part of the account approval process.
In the ideal world, you could do some simple math to get an idea of what kind of score impact you might expect before deciding on whether to apply for this card:
- Calculate the combined account utilization percentage: Total balances divided by total credit limits = Combined account utilization percentage.
- Calculate the new card account utilization percentage: New card balance divided by credit limit = New card account utilization percentage.
Using these calculations, you should be able to compare the new and older card utilization percentages, so that if a new card carries higher utilization than the existing combined percentage, there’s a good chance the score could drop. And conversely, a lower percentage on the new card could lead to a higher score.
Unfortunately, however, this isn’t the ideal world. You won’t be able to make this comparison because you will have no way of knowing the credit limit on the new card until it’s been approved and opened. Only then will you know the credit limit that was established within the automated approval process and be able to conduct this comparison of utilization percentages. By then, of course, it’s too late to decide against obtaining the card.
Despite credit card companies freely sharing most card terms before the approval process, such as interest rates and late fees, credit limits tend to remain a mystery until the split-second process during which the score is pulled, application information is evaluated, the account is opened, and the card is on its way to you.
There are at least two reasons for such a degree of what may seem like secrecy surrounding the granting of credit limits:
The proprietary formulas used to assign the amount of available credit rely on a complex and constantly changing set of consumer information that includes an up-to-the-minute credit score, application information and other factors to help predict how much risk should be taken with this consumer. In fact, much like the credit scoring formulas themselves, the credit limit setting criteria remains a secret, not just to consumers, but also to the card company representatives who receive credit limit-related questions from consumers.
From a card issuer’s risk perspective, it makes sense to review the latest possible credit score before committing to a credit line on a new account. This last-minute credit check helps minimize the typical unavoidable delay of up to 30 days or more between a significant negative occurrence, such as a missed payment or maxed out credit card, and its appearance on a scored credit report.
So here you have the card company taking steps to protect itself from losses due to overextending credit, while the consumer must make a credit score-impacting decision without the kind of information — credit limit amount — needed to make it in an educated manner.
Of course, just because you open a card account doesn’t mean you have to use it. And yet while true, the fact remains that even if you don’t charge on the card and thus don’t incur high utilization, your score still may take a bit of a dive due to those other factors — average age of accounts and inquiries — that can’t be undone.
Now that you’ve had to listen to some bad news, there’s a positive side to all of this. Regardless of your score or utilization percentages, expect to regain any lost points from a lower average age of accounts and additional inquiries within about six to 12 months, as long as all payments continue to be made on time and no other new accounts are applied for. This should also be about the length of time required to recover some of any utilization-related points lost due to a sizable balance applied to the card early on.
Another piece of good news is that, while in most cases the best scenario for a higher score is to leave the account open after paying it off, since doing so ensures the card’s 0 percent utilization will continue to be included in utilization evaluations, it’s also likely that as long as you keep very low percentages on your other two open cards, there should be no damage to your score from closing this one once the balance reaches zero.
Meet CreditCards.com’s reader Q&A experts
Does a personal finance problem have you worried? Monday through Saturday, CreditCards.com’s Q&A experts answer questions from readers. Ask a question, or click on any expert to see their previous answers.