Humberto Cruz

Making up for lost revenue under a new federal law that restricts interest rate charges, many credit card issuers have been slapping new fees on cardholders.

Among the highest I've seen are a $99 annual fee just for having the card and a $60 fee unless cardholders charge at least $2,400 in a year.

So, what to do? Are we better off canceling a card to avoid unwanted fees or will doing so cost us more in the long run?

"We are advised not to close credit card accounts we no longer use because it will hurt our credit score," wrote a reader in an e-mail representative of dozens I've received. "I don't want to pay any fees. How does closing an account really affect my score?"

For the answer, I turned to Craig Watts, public affairs director for FICO, the company that developed the widely used FICO score (The name comes from Fair Isaac Corporation, named after founders Bill Fair and Earl Isaac).

First, a refresher. Lenders use our credit score -- a number generally ranging from 300 to 850 -- to help them determine how likely we are to pay back a loan on time. The higher our score, the more likely we'll be approved for a credit card or loan at attractive rates.

In addition, insurance companies, wireless providers, landlords and employers are using credit scores -- presumably, a measure of how responsible we are -- to help them decide whether to do business with us and on what terms.

That's why having a good credit score is important. The good news is that if we use only a fraction of our credit limit, closing a credit card account won't have much of an impact.

The FICO score formula weighs a number of factors on our credit bureau report. The most important is whether we pay on time.

You can go to http://www.myfico.com/CreditEducation/WhatsInYourScore.aspx for a complete list.

If we have one or more credit cards, the formula considers things such as how long we've had each account open, whether we pay on time and the "utilization rate," which is the account balance divided by the credit limit. For example, if we charge $2,000 and our credit limit is $10,000, our utilization rate is 20 percent.

The lower the utilization rate, the better. The formula also considers the utilization rate for all our cards combined. This is the part of the formula most likely to be affected if we close a credit card account.

For example, I have three credit cards, each with a $10,000 credit limit.

I typically charge $2,000 a month on one card and little or nothing on the others. My overall utilization rate is 6.67 percent ($2,000 is 6.67 percent of $30,000). For an explanation of utilization rate, go to http://www.myfico.com/crediteducation/questions/Credit-Cards-And-Score.aspx.

If you have high balances on one or more credit cards and you close one or more unused accounts, this can increase your overall credit utilization rate and damage your FICO score, Watts said. "To avoid that, you want to close credit accounts when your overall credit utilization rate is very low," he said.

For example, if I were to close one of my rarely used cards, my utilization rate would rise from 6.67 percent to 10 percent ($2,000 in charges and an overall $20,000 credit limit). That rate would still be quite low. While the FICO site does not recommend a specific utilization rate, many consumer advocates recommend keeping it to less than 50 percent, or even 33 percent.

Available at Amazon.com:

The FairTax Solution: Financial Justice for All Americans

The Ultimate Cheapskate's Road Map to True Riches: A Practical (and Fun) Guide to Enjoying Life More by Spending Less

 

Personal Finance - Closing Your Credit Card Accounts May or May Not Damage Your Credit Score

© Humberto Cruz