Credit score is important. Be careful with it

The FICO credit score used by the three major credit bureaus is a three digit number that represents a consumer’s ability to obtain credit. Using a complicated formula developed by Fair, Isaac, and Co, the score takes a consumer’s entire history and turns it into a three-digit number, ranging from 300 to 850. This number allows a prospective lender or creditor to determine, at a glance, whether it is worth their while to do business with the consumer involved.

Most consumers are now aware of the importance of a credit score and they also know that having a higher score means easier credit and lower interest rates on loans. And lenders often recommend that anyone who may be looking for a mortgage in the near future should look over his or her credit report to make sure that there are no errors or any glaring problems that may make a lender think twice about lending money.

The first thing many people do upon seeing their credit report for the first time is marvel at how many old accounts are listed. The department store credit card from your hometown that you haven’t used in ten years may be there, for instance. And the next thing these people do is say to themselves, “This is credit I am not using, and it may make me look like a threat to max this card out. I should cancel it.” And then they do cancel it, and then their credit score drops.

Why is that? Why should a FICO score drop when you cancel an account? Isn’t having too much available credit bad? Well, there is some truth to all of these things. One of the most significant aspects of the score is the length of the financial history. The longer you have had credit extended to you, the better. Lenders like to see that someone has a healthy report, but they really like to see that this health extends over a long period of time. In fact, if you want to have credit score of 800, you want to have a history of 30 years or so. The oldest account on your report will indicate the length of your financial history, and that may very well be that department store charge card that you haven’t even thought about for ten years or more. As long as that account is active, even if you aren’t using it, the better your history. Canceling that account shortens your history and thus, lowers your score.

Should you cancel a more recent card? That’s a different situation. Creditors are concerned about too much available credit; having ten Visa cards might set off an alarm. If you do decide to cancel one or more accounts, it would be in your best interest to cancel relatively recent accounts. Even better would be to cancel recent accounts that have no balance. The accounts, even when closed, will still appear on your report, but they will not affect your overall score.

Before you cancel an account, look at the big picture. Canceling an old one may do more harm than good.

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