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Keep the cards

Personal Finance | What seems like a sound move may end up hurting your credit rating

Issue: "Home again," July 12, 2008

Dear Editor:

We heard a news report about having many open credit cards to improve one's credit score. Is this true? We have paid all our debt off except for our house and truck and closed the accounts. Will this hurt our credit score? How can we improve our score?

We are one of many who have an adjustable rate mortgage (ARM) on our home and want to get out of it. What is the best way to do this?

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Thank you,
Jon and Ruth Carley

Dear Mr. and Mrs. Carley:

You have addressed a number of different subjects in your inquiry, and I will attempt to answer them one at a time. These are important topics, indeed.

It is not so much true that "having open credit cards" helps your credit score as it is true that closing accounts that had a good payment history hurts your credit score. If you have a good payment history on a credit card account, pay your balance down to $0 and leave it open, there is nothing that will hurt your credit by leaving the account open.

However, the merit of your attractive payment history will eventually "fall off" your record if you close the account, thereby costing you positive FICO points (credit score rating) that you worked hard to achieve. I consider that as important as the "utilization" argument, which is that the lower percentage of available credit one is using, the higher his score will be. Put differently, if you have five cards with an aggregate credit limit of $25,000, and there is only a $1,000 total balance, that will produce a better score than a $1,000 balance with $10,000 available credit.

This is a valid consideration, but at certain credit levels it phases out. Ultimately, I think it is best to let good payment histories stay on your record, and to simply cut up or refrain from using cards that you no longer need. And of course the bigger caveat is this: Regardless of the implication to your credit score, the most important thing to do is what you need to do to avoid reckless levels of consumer debt.

The best way to "improve your score" is simply to continue making timely payments on your revolving accounts (house, truck, etc.). Do not unnecessarily apply for credit you do not need (every inquiry has a minor negative effect on your FICO score). Do not be late with payments, and keep balances low or minimal. Eventually, through time, your FICO score inevitably picks this up and reflects it. I have never seen someone with a bad credit score who consistently made payments on time.

As for your question regarding an adjustable rate mortgage on your home: Perhaps the thing to do is evaluate with your mortgage consultant whether or not a fixed rate mortgage is affordable within your monthly budget, and explore changing your loan from the current situation to one that is amortized (i.e., a portion goes to principal) and fixed (i.e., the rate will not change). You cannot put a price tag on peace of mind, and I believe you may be wise to look into this.

With regards,
David L. Bahnsen

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