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Select a Credit Card with a Zero Balance

Select a Credit Card with a Zero Balance

Closing a Credit Card with a Zero Balance

For many people who’ve struggled with debt, when they finally manage to pay off a credit card, their natural tendency is to think “Good riddance.” And many of those individuals will close a credit card balance once it’s paid off.

Select A Credit Card With A Zero Balance

But think twice about doing so – or else two quirks of the credit-scoring system could come back to haunt you.

Select A Credit Card With A Zero Balance

The FICO scoring system operates based on a formula. FICO hasn’t revealed all the ingredients in their secret sauce, but they have disclosed some guidelines.

Select A Credit Card With A Zero Balance

About 30% of your FICO credit score is based on the amount of credit card debt you’ve charged. The lower the amount of credit card debt you’re carrying, the better it is for your credit scores because you’ll have a lower “credit utilization rate.” For instance, let’s say you have just one credit card. It has a $5,000 credit limit, and your balance is $4,000. Your credit utilization rate is 80% because you’ve charged 80% of your total credit line. Not good. Try to keep your credit utilization rate around 25% or less.

Select A Credit Card With A Zero Balance

By closing an account, you could throw off your credit utilization rate, inadvertently lowering your credit scores. For example, let’s assume you have two credit cards, each with a $5,000 limit. You’ve charged $1,000 on each card. So your total credit utilization rate is 20% ($2,000 divided by $10,000).

Select A Credit Card With A Zero Balance

But now you decide to take advantage of a 0% balance transfer offer. So you transfer the full $1,000 balance from one card onto the other card offering you the 0% deal. Then you close the card with no balance. Suddenly, your credit profile has changed – and not for the better.

Select A Credit Card With A Zero Balance

With just one card boasting a $5,000 limit and a current total balance of $2,000, your credit utilization rate has now jumped to 40% from 20%. Even though you haven’t charged a single dime more, you appear “riskier” to the credit scoring system.

Select A Credit Card With A Zero Balance

Another problem: 15% of your FICO score is determined by the length of your credit history. Older, more established accounts boost your credit rating. So closing an account – especially one you’ve had for a long time – could be detrimental to your credit health.

A closed account will still be included in your FICO score calculation. But after 10 years, closed accounts are dropped from your credit reports, so you won’t get the benefit of that credit longevity when your FICO scores are tabulated down the road.

Buying Furniture from a Local Merchant and Using Their Financing

You might think that debt is debt. But all debt is not created equal – particularly when it comes to your credit scores.

Credit card debt, also known as “revolving debt,” is scored less favorably than, say, a home loan. And lower-tier levels of debt, such as furniture store loans, are even further down on the credit totem pole.

So when you buy furniture from a mom-and-pop store, or even a big furniture retailer, and you finance it though that company, it can lower your credit rating because these firms are seen as lenders of last resort. Also, furniture store loans are typically reported to the credit bureaus as “revolving debt.” Therefore, if you get a $1,000 credit limit from furniture store and you proceed to buy a $900 sofa and love seat; you’ll appear to be nearly maxed out, which is bad for your credit score.

Remember, too, that FICO’s credit scoring system grades the type of loans you have in your credit reports. The “mix” of credit you have accounts for 10% of your FICO scores. So having a healthy mix of credit – for instance a mortgage loan, an auto loan, a student loan and a credit card – is a good thing, as long as you pay all your bills on time. But stay away from furniture loans and household finance companies.

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