The Effect of Paying Off and Closing Credits Cards on Credit Scores

Paying off the balance on a credit card and closing a credit card account has two very different effect on your credit scores.

While paying off the balance on a credit card is always good and will serve to increase the credit score closing credit card accounts may have a temporary negative effect on your credit score. This is simply because credit scoring model usually considers several factors in order to calculate a credit score.  One of this practice is called a credit to balance ratio or otherwise known as the debt utilisation ratio.

A debt utilisation ratio is the amount of credit availability you and the amount that you actually use. For example if you have two credit cards one with the credit limit of $5,000 and the second one with a credit limit of $4000 and the total money that you can take on debt at any other time is $9,000.  If at a given point of time the total amount that you have charged on both these credit cards is $3000 than your debt utilisation ratio is 33%.  However if you close the credit card with the $5,000 limit than your debt utilisation ratio approaches close to 90%.

Using up credit close to the maximum limits that is available to you is not considered favourably when calculating the credit score. This is because it seems that you are taking on a large sum of money on credit and hence are running a greater risk of defaulting on the credit account. The lenders may feel that since you are charging close to the maximum limits you are spending beyond your earnings and a using credit to supplement your income.

Keeping the balance low usually signifies that you are using your credit well with a well planned approach as to how to repay them. However, it should be noted that the effect that paying off a balance on a credit card will have on your credit score also depends on the other information present on your credit report. 

If your credit score is being negatively impacted by other factors than paying off the balance may not have much of an effect.

Likewise, if you have other positive accounts on your credit report that in use regularly and conservatively with the history of rental payments than closing a relatively inactive credit card account may only have a minimum negative impact on your credit score if at all.

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