You probably already know some of the credit mistakes you could make. For example, you probably understand that not paying your bills on time is one of them. You might also know that letting a bill go to collection is a mistake. However, there are some credit mistakes that are not so apparent.
The biggest credit card mistake – closing credit card accounts
There it is. The worst credit mistake you can make – and one that you may not even be aware of – is trying to improve your credit score by closing credit card accounts.
Are you surprised?
This could come as a surprise to many people and could be startling news for people who have worked for years to pay off a big credit card debt. You finally make that last payment and just can’t wait to call the card’s consumer service department and tell it to cancel your card immediately.
Resist the temptation
As tempting as this might be, take a deep breath and back away from the telephone. The fact is, this could be the biggest mistake you could ever make – depending on your financial situation. And it could be years before your see the repercussions of this. That’s because if you have a credit card account that shows zero delinquencies, it will stay on your report for 10 years after you paid if off. And this will help your credit score.
Of course, after those 10 years, it will drop off your credit report and you’ll lose all of the good history that’s associated with the account. Plus, your overall length of credit history will drop when that account does go away and your credit score will take a hit accordingly.
If you close the account
Conversely, if you close that account it will drop off your credit report immediately, which will damage your credit score. The reason for this is something called your “credit utilization ratio.” This makes up 30% of your credit score and is a fancy way of looking at how much credit you have available vs. how much you’ve used. As an example of how this works, let’s suppose you have combined available credit of $15,000 and you owe a total of $2000. You would then have a debt-to-credit ratio of about 13.3%. This will have no effect on your credit score. However, if you close, say, two of your credit card accounts, your combined available credit might drop to $5000 and your debt-to-credit ratio would balloon to 40%, which would have a very adverse effect on your credit score.
There are exceptions to this credit card mistake
Of course, there are exceptions to this rule. There are times when you might want to close a credit card account. For example, let’s suppose you’re able to find a card with a lower interest rate and better rewards and with a credit limit that’s at least equal to or more than the one you’re thinking of closing. In this case, closing the other card could make sense. Alternately, you might be able to raise the credit limits on your other cards to make up for the hit your debt-to-credit ratio would take if you do close that one card.
Tips for closing a credit card account
If you have good valid reasons for closing a credit card, there are three things you could do to minimize the damage it might cause to your credit score.
- Pick the right card. Do not close the card that you’ve had for the most time or that has the highest credit limit or the lowest interest rate and fees. Choose a card instead such as a store credit card as they usually come with the lowest credit limits and the highest fees.
- Choose the right moment. Don’t close the card right before applying for a loan. This could result in a higher interest rates. If you do need to close the card, wait until you have been approved for the loan.
- Watch your ratio. Before you close that card, see if you can get higher credit limits from the cards you already have. But don’t do that unless you first talk with a credit card company rep to make sure this won’t generate a hard inquiry.
The financial guru, Dave Ramsey, advises you to avoid credit entirely. We disagree with this. Credit can be your friend. In fact, if you’re typical, credit can help you achieve goals such as buying a home, a car or achieving financial security. The important thing is to use it wisely. Watch your debt-to-credit ratio and make all of your payments on time every time. Try to not carry any balances forward because you would then be required to pay interest, which is just money out of your pocket.
More tips about credit card mistakes
Here are some other mistakes you could make with credit cards. Don’t …
- Ask for a lower limit
- Pay off an installment loan early
- Open a bunch of cards at once
- Settle a debt for less than you owe
- Use prepaid cards to rebuild your credit
- Check your credit daily
- Stop using your credit cards entirely
How the credit card companies make money
The credit card companies don’t make much money if you pay off your balances every month. Their business model is based on the fact that once you start carrying balances forward, you’re likely to begin making just their minimum monthly payments.
Next time you receive a statement from one of your credit card companies, compare the minimum payment required to your interest charge for that month. It’s likely that the minimum payment will be about the same as the interest charge. If this is the case, it means that so long as you make only the minimum payment, you’re doing nothing to reduce your balance and could literally be in debt forever.
Here’s a short video that reveals five credit card mistakes to avoid at all costs.