Dangers of Canceling Unused Credit Cards

There’s been quite a bit written about the dangers of credit cards and how if used irresponsibly they can wreak havoc on an individual’s financial well-being. Financial experts agree that if you’re going to use a credit card that you exercise caution. For those struggling with uncontrolled debt, experts have been recommending for years that simply canceling your cards, in particular your unused credit cards, is the best way to go. The reality is that there are both drawbacks as well as benefits when canceling a credit card, but most people are totally unaware of the potential pitfalls when closing these accounts. When closing any credit card account, you have to be mindful of a few things. If you are an individual who has struggled with spiraling credit card debt because of irresponsible use, closing those unused credit card accounts might just seem too obvious. The bottom line is this: if you’re out of control and you do not have enough self- control to stop using the cards, call your card issuer and cancel the account right away. No matter what anyone else tells you about keeping those accounts active, if you can’t stop using them and you continue to pile on more debt, your headed for deeper trouble.

But for those that do not have an out of control credit card debt problem, the dilemma with closing an unused credit card account is that it might actually end up hurting your credit score in a number of different ways. There are several factors that FICO uses to determine your FICO score, which is their proprietary measure of your credit-worthiness:

1. Your Payment History (35%)
2. Amounts that You Owe (30%)
3. Length of Your Credit History (15%)
4. New Credit (10%)
5. Types of Credit Used (10%)

The “amounts that you owe” accounts for 30% of your FICO score and is a measure of your so-called credit utilization ratio. How can closing an account affect your credit score you might ask? Say, for example, you have two cards, each with $4,000 credit limits for a total of $8,000 in available credit. You have a card balance of $1,500 on one of the cards, giving you approximately 17% credit utilization. If you closed that unused card, your total available credit would drop down to $4,000 total and your credit utilization ratio would suddenly jump up to around 38%. This could drastically affect your credit score in some cases. Admittedly, this will only temporarily affect you so long as you were to pay down that outstanding balance. Nevertheless, it can still affect your credit score negatively.

Also, the “length of your credit history” accounts for 15% of your credit history and closing one of those unused cards with a long credit history can also hurt your credit score.

Here’s the bottom line: as long as you keep your card balances at zero, you can close those unused accounts and you will probably not be affected at all, assuming of course that you do not carry a balance and remain vigilant about keeping those card balances paid off. If you do occasionally carry a card balance, closing one of those unused accounts can drastically affect your credit score, depending on how much of your credit that you’re using at any one time.

There’s at least one situation in which you should avoid closing any of those old accounts though. If you plan on taking out any type of major loan in the next year to 18 months (such as a mortgage or a car loan), you’d be advised not to close any of those old accounts. You don’t want to take a chance on dinging your credit score when it matters the most.

This is a guest contribution from Steve Sildon, Senior Editor for CreditCardAssist.com. Steve contributes frequently to the personal finance blogosphere, providing expertise, tips and advice on a variety of credit-related topics.

What is Consumer Confidence?

By Dr Boyce Watkins, appearing as a guest here on Cure Money Madness.

If you listen carefully to the words of Treasury Secretary Henry “Hank” Paulson and Ben “Big Ben” Bernanke (chairman of the Federal Reserve) you might notice a trend in their language. The word “confidence” is used a lot when they speak. Many of their monetary proposals are not necessarily valuable for their financial power, but also for their psychological power.

Some of you may wonder what confidence has to do with anything. After all, if you’re broke, confidence doesn’t exactly put money in your pocket. If you’re 100 pounds overweight, confidence won’t help you win the Olympic 100 meter dash. When you are flying on a crashing plane, confidence doesn’t keep the plane from slamming into the ground. But confidence is important to an economy, and one of the most significant drivers of economic growth. In fact, over confidence has driven US economic growth for the past 10 years. Here are some reasons that confidence matters in the minds of Hank and Big Ben:

1) Confident consumers spend money

If you think you might lose your job next year, are you going to max out your credit cards? I certainly hope not. If you are worried about being able to make ends meet, are you going to buy that big screen TV? Not unless you want your wife to leave you. So, even if it doesn’t hold any truth, the mere forecast of a weak economy is enough to make many Americans hold off on consumer spending, one of the great driving forces of the American financial system.

2) Confident companies invest money and hire workers

Investments involve risk. Your hunch may work out, and it may not. If you don’t believe the economy is getting better, you are not going to consider taking that risk. No one plans to go to the beach if the weather man says that it’s going to rain. When economic rain is in the forecast, companies pull out their umbrellas and hold off on new projects. This reduces the number of jobs in the economy, because nearly every job created in America is the result of someone making an investment.

3) Confident Americans do not take their money out of banks

In case you didn’t know, your bank does not have your money. Your money is part of a large base of financial capital that is loaned out to individuals and consumers seeking to get a good return on their investment. So, without investing, your bank would have no interest in paying you any interest at all. So if, say, 30% of all customers of the same bank decide to get their money out at the same time, the bank would have serious financial problems. It is a lack of confidence that could cause customers to “run” on their bank and take out their money.

4) Confident investors keep their money in the stock market

The stock market is a place where fortunes are made and lost. Some part of that fortune is psychological, given that no asset can have a value which exceeds that which someone is willing to pay for it. When investors lose confidence, they take their money out of the stock market, and reductions in demand for stocks lead to massive paper losses in the market. Additionally, most Americans are “momentum traders”, meaning that when the market goes up, they tend to buy more, and when it goes down, they tend to sell. History shows that it is actually the opposite approach that tends to work best.

5) Confident banks make loans

Banks have to keep a certain portion of their funds on hand at all times to meet federal requirements. If they are fearful that their customers might come and demand their cash, they hold onto their capital to ensure that it is available. If they are afraid that their borrowing customers will not be able to repay loans due to a weak economy, they also hold back on issuing new loans. The truth is that when economic forecasts are grim, conservative bankers become even more fearful than the rest of us.

The bottom line of this article is that confidence matters. So, the next time you hear Ben Bernanke give a speech, you can be confident that he is going to use language that makes you feel more secure. Whether you choose to believe those words is up to you.

Dr. Boyce Watkins is a Finance Professor at Syracuse University. He does regular commentary in national media, including CNN, BET, ESPN and CBS.

For more information, please visit his blog :  www.boycewatkins.com.

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