Canceling credit cards may sound wise, but is it?
Move may have helped reader get mortgage, but may hurt in long run
Dear Credit Score Report,
I recently locked in a good refi rate on my mortgage. The lender told me it wouldn't hurt to cancel a few bank credit cards that had large credit limits and no balance. I still have other credit cards with large limits and balances less than 50 percent to credit limit. I canceled the cards. Was this wise, as I have concerns that it might lower my credit score? -- Tim
The lender should have been more clear with his wording. The key question isn't whether it "wouldn't hurt," but whether closing those cards helped your loan approval at the expense of your credit score.
Unfortunately, I can't say how closing those cards impacted your credit score specifically. (If you knew what your score was previously, you can buy your score again at MyFICO.com and see if it's changed.) But here's what I do know: Many credit experts discourage borrowers from canceling credit cards, even unused ones, since closing accounts eliminates credit lines from your credit reports. That change can increase your utilization ratio -- the comparison of outstanding balances to available credit -- resulting in a lower credit score. But such a change may not concern your mortgage lender, since your credit score is only one factor they consider. "Some mortgage lenders don't like to see too much 'available credit,' but that's a separate calculation from the FICO score," says credit expert Evan Hendricks, author and publisher of the "Privacy Times" newsletter.
Why the concern over unused credit? "There's too much potential risk for the mortgage lender for the consumer to have this much unsecured credit" available, says Craig Focardi, a senior research director in consumer lending with advisory services firm TowerGroup.
However, what you did to please your mortgage lender could make you less appealing to future potential lenders. According to some experts, borrowers' credit utilization shouldn't exceed 30 percent of their credit lines. That ratio is important because the amount of debt you carry is a heavily weighted component of your credit score. So having a relatively high ratio (45 percent? 49 percent? You don't specify) like yours is typically discouraged. "Generally speaking, the lower the utilization ratio, the better the FICO score," says FICO spokesman Jason Sprenger.
As for why the lender encouraged you to cancel those cards, only he or she knows for sure. Experts have some ideas, though. Most likely, the lender worried about what could happen if you were approved for a mortgage and then maxed out those credit lines that, at that time, were unused. Perhaps a job loss or medical emergency (and the resulting hospital bills) would send you rushing to borrow cash -- fast. If you borrowed a bundle of money on your credit cards, that additional debt burden could make repaying your mortgage lender suddenly more difficult.
Therefore, the lender is likely just protecting your loan in a time of great economic uncertainty. After all, there are some things that credit scores just can't predict -- such as unemployment. "Because credit scoring was found to be not completely predictive of mortgage defaults (a number of high credit score consumers defaulted during the past and current mortgage crisis), banks are definitely moving to add more traditional underwriting methodology in making credit decisions," Ira Rheingold, executive director for the nonprofit National Association of Consumer Advocates (NACA) in Washington, D.C., says in an email. In other words, a good credit score just isn't enough anymore. By asking you to close some of your cards, the lender seems to be encouraging practices that would prevent you from getting into a financial hole and leaving them with an unpaid mortgage loan.
So while your lender is giving out advice, I'd like to offer my own suggestions aimed at strengthening your credit score. Start by paying down your remaining credit card debt. If you can't pay your balances off entirely, at least lower them to less than 30 percent of your available credit. Additionally, look over your credit reports, making sure to dispute any errors that could further hurt your credit score. While you're doing all that, avoid opening any new credit cards or taking on other loans that you don't absolutely need, since credit applications also have the potential to lower your score.
In the future, be willing to question your bank if someone asks you to do something you aren't so sure about. "The better response is to engage the lender and ask, 'If I keep these cards, will [you] still approve my loan?,'" Hendricks says.
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