It takes a lifetime to build a reputation. And that’s exactly the stance credit card companies take.
Here’s a scenario: Sarah is 25 years old, and trying to get her personal finances in order. The first thing on her list is getting her credit card debt situation in control, and she finds herself looking at her two credit cards. One is a retail card that she got on her 18th birthday from her favorite store, Target. The other is an everyday American Express (AMEX) card that she got after college.
By now, Sarah understands that she must pay her balance every month and on time in order to avoid the dreaded “credit trap.” But now, she wants to simplify her spending and increase her credit score, so she picks up the phone with a plan to cancel her old Target credit card.
But should she?
Should you cancel an old credit card? Consider your FICO score
You may have found yourself in a similar situation. Before you cancel an old credit card, consider how it will impact your FICO score:
- 30% of your FICO score = Debt owed to credit limit available
Each of Sarah’s credit cards has a limit of $5,000. Sarah pays roughly $500 on her Target card, per month, and another $1,000 on her AMEX. She’s currently utilizing $1,500 of her credit limit, compared to a $10,000 overall credit limit — so, she’s using 15%.
Sarah wants to stop using the Target card and stop spending the extra $500, so she wants to cancel the card. If she does so, Sarah will be using $1,000 per month of her $5,000 credit limit — that which gives her a higher usage of 20%, and which could negatively impact her FICO score.
Simply put, canceling her old card, even though she doesn’t want to use it anymore, will decrease Sarah’s total credit limit available. Now, even though you are being more frugal and spending less, the ratio of how much you owe (debt) to how much you have available (credit) is still not in your favor.
It’s a bit unintuitive, but from a lender’s perspective, it appears that you’re further in debt than you’d be otherwise!
Expert tip: Try to maintain your current debt (usage) of credit available below 30%.
15% of FICO score = the length of your credit history
The importance of credit history
What is the first question asked during most job interviews? “Do you have any experience?” Experience is the catch-22 of the corporate world — you need it to get a job, and you can’t get it until you have a job. This is oddly like applying for credit.
Remember, it takes a lifetime to build a reputation, and lenders want to take a look at your reputation. Credit companies want to see how long you have been making payments, building up your credit, and being responsible. In their eyes, if Sarah cancels the older of her two cards, her reputation has been cut from seven years down to only three — reducing the length of her credit history, and negatively impacting her FICO score.
Looking at how often and where she uses the AMEX card, it is easy to see the everyday card is more practical to keep. But the second reason she probably doesn’t want to cancel that old Target card is that she got it on her 18th birthday — four years before the AMEX card.
Remember: 10% of your FICO score = Mix of loan and card types
Congratulations! You got a promotion to manager. You are now responsible for making sure not only your job is completed, but also Todd’s job (and everyone else’s) as well. If you can prove that you can handle the responsibility of two people’s production, you will be allowed to take on more and more responsibility in the future.
Once again, the job analogy reflects the view of a credit company on how they score you. If you can prove you can handle your job and complete all your tasks on time, you will be rewarded with a positive score. If you can prove that you are also capable of handling different types of jobs and different types of responsibility, then you will be rewarded even more.
The credit company wants to see that you are responsible enough to manage more than one type of debt. Down the road, you will get points for having an auto loan or a home mortgage. For now, holding onto the two cards and proving you can handle the responsibility of different lines of credit and different payment dates will have a positive impact on your FICO score.
When should I cancel my old credit card?
If your old card has some sort of annual fee attached to it, there is no need to pay $50 per year for a few FICO score points.
What is the best plan of action?
Go into the drawer, get out a pair of scissors, and cut up your old credit card. This way you won’t be tempted to use it, but you will maintain all the positive effects on your FICO score mentioned. Then when you do want to use the card again, you simply call and get a new card mailed — don’t cancel it, just destroy your physical copy.
What are my next steps?
- Take out the credit cards in your wallet and compare
- Ask: Which has the longest history, which have fees attached, and which do I see myself using going forward?
- Go get some scissors!
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