Should I close my credit card to get my score mortgage-ready?
Lenders want to minimize risk, but closing accounts can hurt credit score
Steve Bucci has been helping people decode and master personal finance issues for more than 20 years. He is the author of “Credit Management Kit For Dummies,” “Credit Repair Kit For Dummies,” “Barnes and Noble Debt Management,” co-author of “Managing Your Money All-In-One For Dummies” and “Debt Repair Kit For Dummies” (Australia). Steve is an experienced expert witness in identity theft, credit scoring and debt related cases. He has been a presenter at the FICO InterACT Global Conference, the Federal Reserve and the International Credit Symposium at Cambridge University in the UK.
Should I close a credit card to get my score mortgage-ready?
Closing a credit card account can lower your credit score by increasing your overall credit utilization. If you already have a low credit score, a better way to improve it is to pay down any high card balances you have. Zero is the best utilization percentage, but if that’s not feasible in the short term, you should try to pay them down to 30 percent or lower.
Dear Keeping Score,
I am looking to buy a house, but my mortgage officer stated that my credit score needs to increase from 571 to 600 to be able to qualify. My debt-to-income ratio is about 47 percent. However, all but about $8,000 of the debt will be paid off with the sale of our current home, and the purchase of a new house would have to be contingent on selling our home.
My mortgage officer suggested that I use an app to see which scenarios will increase my credit the fastest. I currently have three open credit card accounts (limits of $3,000, $1,000 and $1,000), all of which are maxed out or within $200 of being so. The app simulator suggests that by closing my oldest account (the one with almost $3,000 on it) and paying my remaining debt down by $1,000, my credit score will increase to where I need it to be.
However, everything I’ve read online about closing credit card accounts seems to recommend the exact opposite because it has a negative effect on credit. Can you clarify the effects on closing an active account down? – Nick
I am afraid that the advice you are getting is too narrowly focused and could get you in a lot of trouble. While it is generally correct, everyone’s situation is unique. I don’t believe you’re getting the whole story as it pertains to you personally.
It is true that closing an active account can have a negative effect on your credit score. This is because you lose the available credit from that card relative to the entire amount of credit you currently have available compared to your overall outstanding debt. This is called credit utilization, and it accounts for 30 percent of your FICO score.
Let’s say you have credit of $5,000 and debts of $3,000 – a debt-to-limit ratio of 60 percent. If you close a line of $1,000 and keep the debt of $3,000 your debt-to-credit ratio goes up ($4,000 of credit to $3,000 debt, or 75 percent utilization) and that’s not good.
Tip: The effects of both opening and closing a card on your score are short-lived, if you keep your card balances low and make on-time payments.
However, if you lower your debt at the same time as you reduce your outstanding credit, they can offset each other or even improve your score if you drop more debt than credit. In your case, as your accounts are at or close to their credit limits, the damage to your score has already been done.
How to raise your credit score
To raise your credit score, you will need to lower your credit utilization rate substantially. From your question, it would seem that you are at nearly 90 percent credit utilization on your credit cards. When it comes to credit utilization, less is definitely more. My favorite utilization percentage is zero, but I understand that this may not be possible in the short term. To make a difference, you need to get those balances down to 30 percent utilization or less.
If you can hold off on your new home purchase for a year or so I’d feel much better about your prospects going forward. Your score is 571, and that is just plain poor. Unfortunately, borrowers with scores under 620 default almost 50 percent of the time. This is because those borrowers are very vulnerable to any setbacks. A score under 620 gets the highest interest rates and fees because of this high default risk factor.
At a score of 620, you’ll have more loan choices, lower interest and fees and a better chance of not facing a default in the next two years. My advice is to wait and work on raising your credit score and lowering your debt before taking on a new mortgage.
You mentioned that after you sell your home, you’ll still have about $8,000 in debt. I’m concerned that an unexpected repair or other unforeseen event could easily push you over the edge and into default or foreclosure. The early years in a new home are the most expensive, by far!
Tip: Any credit score points you lose due to high utilization can be recouped as soon as the high balance is brought back down and updated at the credit bureau.
How to become mortgage-ready
What you need is a plan for getting those credit card balances down and ultimately paid off rather than closing any existing cards.s
I know that you are planning to use the proceeds from the sale of your home, and that is good, but you should also explore other options for paying off your debt. This could include selling unwanted assets or even securing a second job for a time.
Once you have done that, you will want to keep from using your credit cards for anything more than you are able to pay off in 90 days or less. This will be the most beneficial thing you can do to improve your score, as well as for your overall financial health.
Your payment history is paramount. It accounts for 35 percent of your overall score, and it is the most important factor in FICO’s formula. So, be sure you pay on time, every time.
Remember to keep track of your credit score!