Money Expert Q&A: When Stores Cancel Your Line of Credit

I’ve heard that you shouldn’t close a credit card–even if you don’t use it–because it can have a negative impact on your credit score.  However, I recently got a letter in the mail that my credit card account for an electronics store was closed due to inactivity. Will this have any impact on my score? Why would a bank close a card like this?

–A. Watkins
New York City

A closed account can lower your score because you’ll have less available credit. Consequently, your credit report will show that you are using much more of your available credit than you were before. Credit card issuers often close inactive cards, especially if the balance is zero, because they won’t be able to make money from your account. A portion of their profit is made from interest and fees.

Creditors use a calculation called a credit utilization ratio, which makes up 30% of your credit score. Credit utilization measures how much credit you’re using compared to how much you have available. Your credit score decreases as your balance increases in relation to your total available credit. The more unused credit you have, the better your score because it shows creditors that you’re responsible. This makes you a better credit risk. It’s best to utilize no more than 10% to 30%. Financial advisers give different percentages, but most agree on this range.

The degree to which the closed account affects your score depends on how much credit you have available. You didn’t mention how many credit cards you have, but if you have a few, let’s say more than three, it might not make that much of a difference if your account is closed. However, if you have two cards (the recommended amount), there will be more of an impact since there will be a lot less available credit.

This Q&A appears in the September 2010 issue of Black Enterprise in Shopsmart.