The credit scoring formula considers a closed card’s most recent credit limit when calculating utilization, so it won’t be considered “maxed out” if it still has a balance. If you want to improve your score, focus on making the remaining payments on time and getting the balance to zero.
Dear Keeping Score,Hi, I’m wondering if paying down a closed account to get the balance below 30% will help my credit or not. I had a high balance and missed a few payments on a business credit card so they closed it. I got it current and have been making the regular minimum payments.
I have read that getting the balance down to 25% of the credit limit will help your credit score. Do you know if this will help even if the account is closed? Or does that only matter on open accounts? Thank you. – Jeff
I’m glad you wrote to me about your issue as the answer is not what most people would think.
Credit score effects can be tricky to predict. After all, their business is to predict what might not be visible to a lender – real risk. So, while you might think that a closed account with no credit available would be scored as 100% utilized, you would be wrong.
Although mathematically correct, for risk prediction, it’s wrong. Don’t be misled by the fact that the account is closed. The real damage comes from being late on payments.
Consider a credit card holder who is current on all payments. Let’s say the credit card issuer changes the terms of the agreement. This happens all the time. The new terms are no longer advantageous to the card user, so to preserve rights under the current contract the user cancels the card.
The payoff going forward will be based on the old agreement even though the account will be closed to new charges. The account’s available credit will effectively be zero. But has the account holder’s risk level increased? No!
Your closed card account won’t be considered ‘maxed out’
The crafty credit scoring elves take this into account when generating a score for the user. They will look at the credit limit at the time the card was closed, not the current credit limit, as reported by the lender to get an accurate risk assessment.
Those same credit scoring elves also look at your overall debt-to-credit ratio. So, what you owe on your closed card is combined with what you owe on your other obligations and then compared against the total amount of credit you have.
Let me illustrate: say you owe $1,000 on your closed card and have a $2,000 limit (50% utilization) but also owe another $2,000 spread over your other cards. But all your lines of credit total $15,000 over those same cards.
The result is that you owe $3,000 with a credit max of $15,000, or an overall utilization of only 20%. So, while paying down your closed debt will help on utilization, it’s more important to focus on the payment history aspect of your score.
Accounts that are late, including closed accounts, score negatively. They cost you points in your largest scoring category: payment history, which is worth 35% of your FICO score. So damage here is extremely, well, damaging!
The good news is that you are now current in payments on your closed account. As a result, the impact of past late payments will fade as time passes and as recent on-time and as-agreed payments show up on your credit report. More generally speaking, if you consistently pay your bills on time, keep your debt as low as possible and apply for new credit only when needed, you can reach and maintain a good FICO score.
Don’t just pay the minimum on your closed card’s balance
I’m guessing that the interest rate on an account that was delinquent and subsequently closed by the lender is a stiff one. You will be well served to be working to get this account paid off as quickly as you can from both a financial and a scoring perspective. The sooner you can get your utilization below 25% the better.
As you have noted, a low utilization ratio is a scoring plum. The 25% credit line utilization is approximately the number above which you lose points and below which you gain them. High scorers tend to have utilization ratios in the single digits.
Unfortunately, minimum payments are not really structured in a way that will reduce what you owe. You don’t say in your question how much debt we are talking about here, but for your own enlightenment, a good exercise for you would be to check out our credit card minimum payment and payoff calculators.
As an example, a $3,000 balance with a 17% interest rate would require a minimum monthly payment of about $90. But remember that when you are paying down a balance on a credit card and not incurring any additional charges, your minimum payment will slowly decrease each month.
The table from this example has the minimum payment going from $90 to $88.58 to $87.17, all the way down to a final payment of $17.30. The kicker is that final payment doesn’t come around for 126 months, or more than 10 years!
But if you were to take that $90 payment you started out with and continued to pay that same amount each month, your debt could be paid off in 46 months, or just under four years. This is about as sweet a “get out of jail free card” as you can get.
It is true that most consumers would probably start to pay a little more than the minimum at some point. But some never do. Lower required payments every month can feel like a little disposable income bump if a bill is just considered a monthly obligation that is never going to end. That is no way to live your credit life.
Business card account may not even appear on your credit report
I’m making an assumption here that even though this was a business credit card, you personally guaranteed the card when you took it out. If not, it would not be counted on your personal credit. Have you checked your credit report to be sure that it is being reported?
You are entitled to free reports from all three credit bureaus every year at AnnualCreditReport.com. I recommend that everyone check all three reports annually, even if you don’t think you have a problem. Mistakes in credit reporting are common and the only way to know for sure is to check for yourself.
In the meantime, I strongly suggest you find a way to increase the amount you are paying on this debt so it can be paid off as soon as possible. That is going to be what is best for your score and for your overall financial health.
Don’t neglect any other credit obligations while you are trying to take care of this. Your credit score is driven by your entire credit picture, so pay all of your bills on time, every time.
I would not suggest trying to obtain any new credit until you have a handle on all of this, because simply applying for a new card, whether you get approved or not, will bring your score down, and with this blemish on your record, you might not qualify anyway. No need to take a double hit if you can avoid it.
Remember to keep track of your score!