Is a Closed Account Good or Bad for Your Credit?
Understand how closing financial accounts affects your credit score. Learn when it benefits and when it harms your financial standing.
A closed account can have varying impacts on your credit, depending on several factors. The effect is not always straightforward, as it hinges on the type of account, its history, and your overall credit profile. Understanding these nuances can help in making informed decisions about your financial accounts.
Understanding Account Closure
An account closure means a credit account is no longer active for new charges or loans. This can occur voluntarily, by the account holder, or involuntarily, by the financial institution. The account’s status is updated with credit bureaus.
Accounts closed include revolving credit like credit cards, and installment loans such as auto loans or mortgages. For installment loans, closure means the loan is paid off. For revolving accounts, the issuer might close it due to inactivity, missed payments, or a significant drop in the account holder’s credit score.
How Closed Accounts Affect Your Credit
Closed accounts appear on your credit report, influencing your credit score based on their history. Accounts closed in good standing can stay for up to 10 years. Those with negative information, like late payments, remain for about seven years from the date of the original delinquency.
The length of your credit history is a factor in credit scoring models, accounting for 15% of your FICO score and 10-21% of your VantageScore. Closing older accounts can reduce the average age of your accounts, negatively affecting your score, especially if it’s your oldest account. A closed account in good standing continues to contribute to your credit history, mitigating immediate negative impact.
Credit utilization, the ratio of balances to total available credit, contributes about 30% to your FICO score. When a credit card account is closed, its available credit limit is removed. If you carry balances on other cards, this reduction can increase your credit utilization ratio, lowering your credit score. Experts suggest keeping this ratio below 30%.
Your credit mix, the diversity of your credit accounts, plays a role in your credit score, accounting for about 10%. Closing a type of account unique in your credit profile could affect this mix. This factor has less impact on your score compared to payment history or credit utilization.
When Closing an Account Is Favorable
Closing an account can be beneficial. Closing credit cards with high annual fees saves you money. Before closing, it may be possible to downgrade to a no-annual-fee version of the card with the same issuer.
If you struggle with overspending, closing a credit card can remove the temptation to accrue new debt. Consolidating debt might lead to closing old, high-interest accounts to prevent further accumulation. Closing joint accounts after a divorce or separation is a necessary step to untangle shared finances.
When an installment loan is fully paid off, the account closes. This reduces your debt burden and improves your debt-to-income ratio. Paying off the last installment loan might cause a temporary, minor dip in a FICO score due to changes in credit mix or age of accounts, but long-term financial benefits outweigh this short-term effect.
When Closing an Account Is Unfavorable
Closing accounts can negatively impact your credit score. Closing your oldest credit card is not advisable, as it can shorten the average age of your credit history. This is impactful if that account represents a significant portion of your credit longevity.
Closing multiple credit accounts simultaneously can be detrimental, as it can drastically reduce your total available credit and average account age, leading to a drop in your score. This increases your credit utilization ratio across remaining accounts.
Accounts with high credit limits but low or zero balances are valuable for maintaining a low credit utilization ratio. Closing these accounts reduces available credit, causing your utilization ratio to spike if you carry balances on other cards. It is better to keep such accounts open, even if rarely used.
If an account is involuntarily closed by a lender due to missed payments or negative account management, this negatively impacts your credit score. These closures indicate risk and remain on your credit report as negative information for approximately seven years.