Will closing a credit card lower my score?

If all of your cards have zero balances then you have nothing to worry about, whether you close cards or leave them open. However, if your credit reports show balances on any other cards then read on, as closing cards could hurt your score if you're not careful.

Credit utilization is the scoring formula's way of assessing how much of your available credit is being used, with lower utilization leading to a higher score.

The following "before and after" scenarios will illustrate how impacts to utilization from closing cards can differ substantially, depending on whether or not you carry balances on any of your cards.

Scenario 1 (both cards have $0 balances): 
Both cards A and B are open. Both have $0 balances. Combined utilization is 0%. 

Card A is then closed, while Card B is left open. Both have $0 balances. Combined utilization remains at 0%.

Result: In scenario #1, despite removing $1,000 of available credit, which is what happens when you close $0 balance cards, there is no impact to utilization from closing Card A.

Scenario 2 (one card carries a balance): 
Both cards are open. Card A has a $0 balance, while Card B carries a $500 balance. Combined utilization is then 25%.

Card A is then closed, while Card B is left open. Combined utilization increases to 50%.
 

Result: In scenario #2, removing $1,000 of available credit from the balance/limit calculations doubles the utilization percentage from 25 to 50%, despite the same amount of debt. While a doubling of the utilization percentage will not occur with every closed card, and your mileage will certainly vary in these situations, the simplest lesson to learn from this exercise is to keep cards open whenever possible, especially if you tend to carry balances on other cards.

How Credit Impacts Your Day-to-Day Life

Credit influences many things that affect our daily lives, including our home and job. Prepare your credit for apartment hunting, job applications, insurance shopping, and opening new utility accounts. 

 Apartments

Your credit report is often pulled by a landlord or rental agency as part of the review process. They will also check that the name, address, and employer on your report match what you put on your application.

Auto loans 

Your credit score commonly influences auto loan rates available to you.

Cell phones

Cell phone companies will check your credit score before deciding to grant you a service plan. People with credit issues may be asked to put down a large down payment or pay extra for a service contract.

Child support enforcement agencies

Child support enforcement agencies can check the credit histories and child support payment records of delinquent parents. Non-payment can damage credit scores.

Credit cards

When you apply for a new credit card, the company will review your credit score to see if you qualify and what terms you should receive. Credit card companies often review the credit scores of existing customers and in turn may adjust their rates.

Employers

Employers must get written permission before they can review an applicant's credit report. Usually employers review your credit report for major negative records or discrepancies.

Government assistance and licensing

Technically, any government agency can access limited information from your credit files without your permission (name, address, former addresses, current and former employers).

Insurance

Home and auto insurers commonly use consumer credit information along with your application data in determining rates and terms. In fact, more than 90% of auto insurance companies now use credit data.

Mortgages

Mortgage lenders usually review all three of your credit reports and credit scores as part of the application process.

Utility Accounts

Electricity, cable, and other utility companies may check your credit report with your permission when determining your rates. People with credit issues could be required to put down a deposit, add a co-signer, or pay higher rates for their utilities

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There are many ways you may inadvertently lower your credit score

One way is renting a car with a debit card. Paying for a car rental with a debit card can actually HURT your credit rating. The reason is that most rental contracts give the rental car company the right to check your credit rating if you use a debit card instead of a credit card. Each time someone checks your credit rating, it’s a negative – just like if you are seeking a loan.

Here are other innocent actions you may take that may also damage your credit score:

- Closing a Credit Card with a Zero Balance

- Having a Credit Card Company Not Report Your Credit Limits

- Paying off an old debt or an account in collection

- Having multiple names listed in your credit reports

5 Major credit scoring models

Credit scores are one of the most important components of a consumer’s personal finances. It dictates the quality of the loan you would be eligible for as well as the interest rate which will be tacked on to the borrowed principal. Potential lenders and creditors base their decision to grant or deny you a line of credit based on your credit score.

Developed in 1970, the Fair Isaac Corporation introduced a method to measure the ‘creditworthiness’ of an individual. It took into account multiple factors like the length of an individual’s credit history, recent ‘hard’ enquiries, credit usage ratio, etc. while calculating the score. 

In the years following the formal adoption of the FICO scoring system by businesses and lenders all over the nation, a handful of consumer and credit analytics company developed their own credit score formulas and scoring models. Currently, there are 5 different types of credit score formulas (including the FICO formula) in circulation, each with varying characteristics. This has caused much confusion within the consumer community.

Here is an analysis of the major scoring formulas.

The FICO score
This is the most widely adopted credit score and scoring model in the industry. The Fair Isaac Corporation is the father of the FICO score and is the originator of the credit report concept. Credit reports are generated by the three leading credit reporting agencies (CRA), namely, Experian, TransUnion and Equifax. Since every creditor doesn’t report to all of the 3 credit reporting agencies, FICO scores generally happen to vary from CRA to CRA. Sometimes, the score point deviation can be as much as by 80 points. The FICO score scale runs from 300 to 850 points.

The PLUS score

PLUS is an acronym for Plan, Live, Understand, Succeed and this particular scoring model was developed by Experian. The formula and the score calculation system was developed solely keeping consumers in mind. Unlike the FICO score scale, the PLUS score ranges between 330 and 830. The Experian PLUS score is not the same as the Experian ScoreX PLUS which is not available to consumers.

The VantageScore

This particular scoring model was developed in 2006 as a joint venture between the top 3 credit reporting agencies. The scoring model had been developed to compete with the FICO model and scoring system but failed to catch on. Very rarely do lenders and financial institutions use this particular scoring system. One of the major advantages of the VantageScore model is that the score gaps between reports generated by all the 3 major CRAs are significantly smaller since the scoring model and the underlying computational algorithm used by the 3 CRAs are the same. The VantageScore scale ranges from 501 to 990.

There are two more scoring systems which are little known and rarely used by consumers. These are:

TransUnion TransRisk Account Credit Score

The proprietary scoring model was developed by TransUnion and free credit score providers like Credit Karma are known to use it. TransRisk offers separate scores for home and auto loan accounts. Their scoring scale ranges from 300 and 900 while home and auto credit score scale ranges between 150 and 950.

Equifax Score Power

This particular score is not based on a different scoring model. Rather, it is the name Equifax uses for the FICO based score that appears on the credit reports generated by Equifax.

One of the more important things to note is that the score varies according to the scoring model used for the calculation. Therefore a FICO score of 750 is in no way comparable to a PLUS score of 750. Other than these 5 scoring models there are a few others which use different parameters to calculate credit scores although most lenders refrain from using them.

Don’t Buy Non-FICO Credit Scores

By now, many people are well-aware that the credit score is an important factor in finances.

The main reason people worry about their credit scores usually has to do with borrowing money.  When consumers think about the word “credit score,” the score they are considering is the FICO score.

Each of the three major credit bureaus has its own score, based on the information in your report. The algorithm for figuring out your credit score for each is slightly different. If you check a web site owned by Experian for your credit score, it will likely be different than your actual FICO score. The same is true of a free credit score site owned by TransUnion or Equifax.

Don’t be fooled; many of those paid credit score sites, and free credit score sites offer scores that are different from FICO. (In fact, Experian was sued for fraud because some consumers think they will get their FICO score when they visit FreeCreditReport.com.)

However, if you are using paid credit score services to look at your score, it’s usually not going to be worth your money. Although you are getting a credit score, it isn’t your FICO score, and it may not provide you with an accurate picture of how lenders see you.