More people are learning about their credit and as they work toward better credit scores, we get many questions about what is true and what isn't.  Sometimes the advice comes from a source considered reliable.  However, the source may be uninformed in all aspects of credit building or may be giving advice from their own perspective as a lender or realtor along with the credit criteria that fits their industry's or company's needs.

MG recently wrote to us with the following:
My banker told me that some of my credit lines are "bad credit" and I should close them – mostly consumer accounts like Home Depot and Best Buy.  They said that regardless of balance or payment history, those consumer accounts hurt my credit score.  Is this true?

The short answer is NO, don't close them.

However, because everyone's credit file is unique to them, there are many variables that could make a difference in that answer.   The reason we say NO is that closing accounts rarely helps credit scores, it usually has the opposite affect and causes a score drop. 

The reason is the second largest part of your score, the Amounts Owed.  This section factors in the number of accounts with balances, the amounts owing on accounts and the Utilization Ratio (UR).  The UR is your balance-to-available-credit-limit.  Having UR over 50% typically hurts credit scores, keeping balances under 25% of the credit limit is optimal.

TYPES OF DEBT
There are three types of debt:
Installment - a fixed monthly payment over a fixed term, such as a mortgage or auto loan.
Revolving - a line of credit available, such as a credit card, where the consumer determines the amount owed on the account due to spending, and the payment amounts revolve, or change, depending on the account balance.
Open - an account with no credit limit and you pay it off on a timely basis, such as an American Express card.

REVOLVING ACCOUNTS
There are several types of revolving accounts:
Major Credit Cards - Visa, MasterCard, Discover, American Express
Retail Store Accounts - Store accounts such as Sears, Bloomingdales, Lowes
Retail Fuel Accounts – Gasoline cards
Lines of Credit - Often attached to a checking account as overdraft protection, these can also be Home Equity Lines of Credit or a HELOC.

On all of these accounts, the consumer is given a limit and decides how much to spend. And all of these accounts are figured in two other parts of your score, the Length of Credit History and the Types of Credit Used. 

Now, back to the Utilization Ratio.  If you have four revolving accounts, a MasterCard, a Visa, a JC Penney, and a Chevron, that are all in good standing with no late 30 day late payments in their history and that have all been opened for more than five years, they are already having a positive impact on three parts of your score. 

If they each have a $1000 credit limit, you have total available credit of $4000.  If the two major credit cards have a balance of $400 each and the two retail accounts, the JC Penney and the Chevron, each have zero balance, the overall UR is 20% ($800 divided by $4000).  If we close the two retail accounts, the overall UR is now 40% ($800 divided by $2000), which is likely to cause a drop in scores.  Additionally, by closing the two retail accounts, the Length of Credit History and Types of Credit Used are impacted, too.

Finally, there is nothing stated by Fair Isaacs Corporation, creator of the FICO scoring formula which is the industry standard, about retail accounts being detrimental to scores.  They do, in fact, suggest retail accounts as part of credit re-building, as they are sometimes easier to obtain than major credit cards.

So don’t close your retail accounts without careful consideration of your overall credit picture.   When you are ready for your Credit Check-up, contact us.  For as little as $100, you’ll get a complete credit analysis with recommendations on which of your accounts to keep, which to close, and how to use them as effective credit building tools.

Thanks, MG, for a great question.