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.
One of the most important factors of your credit score is credit utilization, or how much of your available credit you have used. This factor is second only to payment history in importance to your FICO score. For VantageScore, this factor is weighted even heavier – VantageScore refers to it as “extremely influential.” Even if an account has been closed, credit utilization (along with the other factors that make up your credit score) still comes into play.
Impact on credit utilization
Once an account is closed any available credit on the account at the time of the closure is no longer accessible to you. Because of that, it might seem like a closed account is at 100% utilization since you no longer have access to the account. But it is not as simple as that.
While the factors of credit scoring (payment history, credit utilization, credit age, credit mix, new credit) seem pretty straightforward, the science behind credit scoring is complicated. Credit scoring is all about assessing risk and predicting future default. How much risk is a new lender taking on when they accept you as a new customer?
Closed accounts are a case in point. Accounts are closed all the time for many different reasons and can be closed by either the lender or the user. For instance, a lender might close an account due to nonpayment or non-use, while a user might close an account because the terms are changed by the lender.
So rather than simply calling a closed account 100% utilized, the scoring algorithm will look at what the credit limit was at the time the account was closed because this will give a better assessment of risk, no matter why the account was closed. If your account had 80% of its credit line utilized when it was closed, the debt owed still represents a risk to any lender thinking of giving you new credit. So, it will score lower than if the balance was a smaller percentage of your limit.
Focus on payment history
Credit utilization is not the only factor at play here. Payment history is the most influential factor in FICO scoring and is moderately influential in the VantageScore model. So, if the account was closed for nonpayment, for instance, that is going to heavily impact your credit score. The opposite is true if the account was closed by the user due to a change in terms – if payments were made on time and as agreed, that will be reflected in a positive way even though the account is now closed.
A delinquent debt that hasn’t reached charge-off status (180 days late) and is paid becomes current on your credit report, but a charge-off never does. An unpaid charge-off becomes a paid charge-off if it hasn’t been sent to a third-party collector.
A paid charge-off is much better for your credit report than an unpaid charge-off because it indicates that although you’ve had a serious problem, you eventually paid the bill. Everyone has a hard time at some point, but not everyone overcomes it and pays the bill. Once paid, you’ll get a boost on your credit report and you’ll find getting new credit at a reasonable rate easier.
For many, though, accounts are closed with a poor payment history, and that is what causes the most damage to a credit score. Poor payment history is often the result of the credit card in question having a high interest rate, which makes it more difficult to keep up with. This is especially true if only minimum payments are made. While making minimum payments on time will help you avoid poor payment history, it won’t help you get out of debt.
Make a plan to pay off the debt before adding new credit
Now that you know you will lose points for carrying a debt on a closed card, you will want to have a plan in place to pay off the debt. This is especially important before you look to add new credit to your file. Applying for credit and generating a hard inquiry will ding your score temporarily. You don’t want to add insult to injury by applying too soon and being denied because a closed negative account is still dragging down your score.
The best way to avoid that is to take care of your outstanding debt and begin repairing your credit before you do anything else. And remember to only apply for new credit when you need to, not just because you can. This will help you in all areas of your credit, and your overall financial health.
As noted above, you should do your best to stay out of “minimum payment” territory and focus on making payments that will help you pay off the debt. This handy calculator will help you determine how long it will take you to pay off your debt and how much interest you will pay. If you find you can pay more as time goes on, you should do that. The sooner you can get the debt paid off, the better.
Remember to keep track of your score!