Vision Credit Education, Inc.

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How Much is Too Much Available Credit?

August 25th, 2009 by Kenneth Long

Mortgage brokers say that having too many open accounts can hurt your credit. Fair Isaac Corp, the force behind FICO credit scoring says that closing accounts can lower your score. Yet, a recent FICO study suggests that lowering credit limits can actually increase FICO scores. It makes you wonder who is right! Here is the truth.

It Depends on Your Unsecured Debt Levels

If you are using more than 25-30% of your total available credit on revolving accounts, then either closing an account or experiencing a reduction in your credit limits will reduce your score. There are two reasons for this.

First of all, closing an account will never help your scores and it could actually cause your scores to drop. This was confirmed by Craig Watts, spokesperson for Fair Isaac Corp. Secondly, any lost credit will increase your credit utilization rate which dominates the “total balance” portion of the credit scoring formula. That portion contributes 30% of your scores.

Different Impact for Those with Lower Debt Balances

Having utilization rates below 10% means that you are minimizing your reliance on revolving credit. You represent a borrower least likely to default.

Closing accounts would likely lower your scores. This is primarily due to your curtailing the credit histories of seasoned accounts that you have maintained for many years. The length of your credit history comprises 10% of credit scoring inputs. Instead of closing unneeded accounts, some people find that their available credit has been slashed by their lenders due to the tightening credit markets.

Conventional wisdom and most published reports would suggest that lowering your credit limits on existing revolving accounts would lower your scores, since it could cause a slight increase in your utilization rates if you carry light debt balances on credit cards. A recent Fair Isaac study initially appeared to counter this belief.

If we could hold all other conditions constant, we would expect that a reduction in available revolving credit would either have no impact on an individual’s FICO score or would cause it to decrease. In reality, the information on credit reports seldom stays fixed or constant. Our research shows that an individual’s score may go down, go up, or stay the same after the lender reduces a borrower’s credit limit or closes the account.

This study confirmed that most of the cardholders that experienced credit limit reductions actually had good credit scores. Of these cardholders, a surprising percentage experienced slight increases to their credit scores rather than decreases when their credit limits were cut. However, Fair Isaac spokesman Craig Watts said that these increases were attributable to other factors.

The conclusion is that if you have higher debt balances, you should favor keeping lines of credit open and try to avoid any reductions in your credit limits. While this may not necessarily be easy, you should at least focus on paying down your balances by sending in much more than your minimum payment requirements. Closing an account or reducing your credit limits would lower your scores.

Alternatively, if you have good credit and low or no debt balances, then you might entertain a reduction in your credit limits if you feel you have too much credit. Rather than closing unused accounts, you should instead consider limiting your overall available credit. While no evidence suggests that excessive amounts of available credit could be a detriment to your scores, closing accounts will have either a neutral or negative impact.

Most importantly, consider your immediate and long-term credit needs. The impact of these credit limit reductions is normally fewer than 20 points, whether it is a lower score for those overextended or a higher score for those with almost no debt. Your actual credit needs may be more important than simply gaining a few credit scoring points. This is especially true if you need deep lines of credit to handle small business contingencies or other emergencies. Most importantly, it is better to experience lower credit limits rather than to lose open accounts that have a long and positive payment history.

This entry was posted on Tuesday, August 25th, 2009 at 1:55 pm and is filed under Credit Cards, Credit Scores. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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