Editor's note: This story has been updated in 2012.
Thank you for your More Credit-Card Fees Coming article. I have several cards that I don’t use, and I worry that I could get hit with inactivity fees and other new fees if the card companies look for ways to make money in reaction to the new credit-card law. It seems as though it would be better to close the credit-card accounts rather than have to pay the fees, but I’ve heard that doing so can hurt your credit score. Sounds like a Catch-22. What should I do?
You’re right -- that’s a tough situation. You want to avoid paying inactivity fees or annual fees on cards you don’t use, but closing credit-card accounts can hurt your credit score. If you’re careful, however, you can get rid of those expensive cards you don’t use while minimizing the impact on your score.
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Closing credit-card accounts can lower your score because of the impact on your credit-utilization ratio, which is the total of your card balances divided by the credit limits on all of your cards. If you close cards you haven’t used in a while but don’t pay down the balances on your other cards, your score could drop because your total balance will account for a higher percentage of your overall credit limit.
The impact on your score depends on how much your utilization rises. If your utilization ratio goes from, say, 7% to 15%, then your score will go down a modest amount, says John Ulzheimer, president of consumer education at SmartCredit.com. But if it goes from 7% to 85%, then a score in the 800s could drop into the low 700s or high 600s, he says.
The best strategy is to pay down your balances before closing any card accounts so that you minimize the impact on your credit score. “A better long-term approach is to keep credit-card balances low as a matter of habit,” says Craig Watts, of FICO, the company that created the credit score most lenders use. Ulzheimer recommends keeping your balances to less than 10% of your available credit starting three to six months before you apply for a mortgage or other loan.
Keep in mind that it's the total amount you've charged that counts for your credit score, whether or not you pay the bill in full each month. For more information about improving your credit score, see Fast Ways to Improve Your Credit Score.
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