Don’t close cards. But what if you have no choice?

This post originally appeared October 6, 2016 on CreditCards.com as “Don’t close your credit card accounts to win a mortgage

By Barry Paperno

Dear Speaking of Credit,
I have excellent credit and the four credit cards keep raising my credit limits, which is hurting me when I go to apply for a home loan because they consider the amount that is available something that can be used. What can I do to close two of them and limit the amount of the other two without hurting my credit score? – Barbara

Dear Barbara,
My first reaction to your question is to recommend finding another mortgage company. Closing cards and lowering limits should not be a requirement for loan approval. Research has shown that reducing the amount of available credit, whether by closing cards or lowering limits, does not by itself reduce the risk of future missed mortgage payments. Unfortunately, some lenders seem to have missed that memo.

The recommendation you are getting – that you are hurt by higher credit limits – is wrong and doing you no favors. Such requirements are unnecessary from a credit risk perspective. They are also asking you to damage your own credit. Reducing available credit often results in higher credit utilization (balance/limit) percentages. And in the eyes of credit scoring formulas, the higher the utilization, the higher the risk, and the lower the score.

FICO (formerly Fair Isaac Corp.) essentially blew that “too much available credit is bad for you” theory out of the water more than 25 years ago. They did so by developing credit scores based on millions of actual consumer experiences over many years throughout the U.S. FICO found that consumers who avoided charging too much and paid on time in the past were likely to continue this financially responsible behavior in the future – regardless of how much unused available credit they have on hand.

Fortunately, the practice of requiring borrowers to close cards, lower limits and yet maintain high scores isn’t practiced by all mortgage lenders. Many manage to lend effectively relying on the credit score and other proven measurements of creditworthiness. It’s likely you could find one of these lenders.

But if you must …
However, let’s say you want to hang on to a low interest rate you’ve been fortunate enough to lock into with this lender. Or, by now, you are so deeply invested in this mortgage lender that the last thing you want to do is start all over with another.

So, let’s see how you can avoid, or at least minimize, any damage to your score from closing cards or lowering limits.

Which cards should you close and which limits should you lower? The following five guidelines can help you decide, based on whether you are closing a card or lowering a limit, and whether the account has a balance or not.

1. Closing a $0 balance card.
Closing cards and lowering limits can sabotage your score by raising the all-important utilization ratios (balance/total) that make up almost 30 percent of your score.

Specifically, when a $0 balance card is closed, the total available credit amount (total credit limits) is reduced, as the closed card’s limit is withdrawn from the combined utilization calculations. When utilization increases in this way, it’s because the existing total balances now make up a larger proportion of the available credit.

2. Closing a card with a balance.
When a balance remains on a closed card, and as long as a credit limit greater than $0 continues to be reported to the credit bureau, credit utilization will be calculated exactly as it was before closing until the balance has been paid off. Of course, this can be a good or bad thing, depending on the utilization percentage. If low, it’s helping. If high, it’s hurting.

If the credit limit is reduced to $0 after the card is closed, the account will then be excluded from all utilization calculations, just as with a $0 balance closed card.

3. Lowering the limit on an open $0 balance card.
In the absence of a balance, the individual account utilization percentage on any open card will always result in 0 percent, no matter the amount of the limit. For combined utilization calculations, however, lowering an individual card’s limit will lower the total available credit, which could raise the utilization percentage and lower the score.

4. Lowering the limit on an open card with a balance.
When an open card carries a balance, reducing its credit limit can have one of two impacts on individual and combined utilization – no effect or higher utilization. Here again, since the limit functions as the denominator in the balance/limit equation, both individual and combined utilization percentages increase when the limit is lowered on a card with a balance.

5. A closing/lowering strategy – balance/no balance:
First, close the cards with the lowest credit limits. This will preserve your highest credit limits, keep your utilization as low as possible, and maximize your credit score.

Second, lower the credit limit on cards with the greatest gap between limit and balance. This will avoid or minimize any utilization increases that can lead to a lower score.

 

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