In yesterdays post I talked about how age plays a role in your credit score, in today’s post I’m going to discuss what role the amount of credit you have plays a role.
How Cutting Your Available Credit Can Hurt You
Your available credit plays a big role in your credit score, even bigger than the age of your credit. Cutting your credit available is usually a common pitfall that most people do without even realizing it.
One of the most common reasons people do it though is because they may want to get out of debt, so they cancel their credit cards to stop racking up the debt. Another way might be if you just didn’t use the card anymore and wanted to cancel it. I’ve even heard of people who have had their card canceled because the credit card company deemed the card not active enough.
Whatever the reason cutting too much of your credit can have some serious affects on your score unless done properly.
Here’s An Example To Illustrate My Point
Let’s say you have several different forms of credit available. Below is just an example of what someone might have.
- Credit Card #1 with $5000 of available credit
- Home Equity Line Of Credit with $25,000 of available credit
- Credit Card #2 with $1000 of available credit
- Department Store Card with $1000 of available credit
- Credit Card #3 with $500 of available credit
With all the different credit lines available you have $32,500 of available credit. Let assume in this example that you have no debt on any of these credit lines that means you have 100% available.
Now at this point you should be showing a great credit score but let’s say you decide to cancel your home equity line of credit. By doing this you would be cutting 77% off thus negatively affecting your credit score, a lot.
Now just because you canceled one credit line doesn’t mean that it’ll affect you the same for canceling a different credit line. Let’s say you would cancel credit card #3 with $500 of available credit.
This would be a loss of 1.5% of your total credit available. It would still be a negative effect to your credit score but not as bad as canceling the home equity line of credit.
How To Avoid This Mistake
If you plan on canceling a credit line, close a smaller one first. As in the example above I would cancel credit card #3 first. However what if you like credit card #3 because it has some really great benefits.
In this case I would look to canceling the next credit line with the lowest credit available, but what if you really wanted to cancel the home equity line of credit? In this case I would contact the lender and ask to lower the amount of credit available slowly over time.
If you lower the bigger amount down in smaller increments over time it will affect your credit score but as a result of it being done over time it will not affect your score as bad. Also remember that if you do cancel or lower any credit lines make sure you do it slowly over a period of time. This won’t affect you score as much as doing it all at once.
Next time you go to close credit lines remember this article and you won’t have any problems.
This post was recently featured on The Carnival Of Personal Finance by Budgets Are Sexy.