In the last article I wrote, I discussed 6 common credit myths. One of those was about regarding whether or not to close credit. I wanted to go into more details in this article about closing credit and whether or not you should do it if your bank suggests it.
Recently I was renewing my mortgage and applying for a HELOC and my bank emailed me to let me know that I’d have to close a number of credit cards. It got me thinking about how many clients I’ve worked with who have also been told to close down credit.
But, did you know that you don’t always have to follow their suggestion? Oftentimes I’m able to go back to the lender and say no to closing credit (because I know the repercussions for clients and myself) and negotiate different options.
I want to help you understand why you shouldn’t just close credit you have.
Your credit score is a crucial factor in getting approved for a mortgage and securing favourable terms. One key component of your credit score is your credit utilization ratio, which is the percentage of your total available credit that you’re using. For example, if you have a total credit limit of $10,000 and a balance of $2,000, your credit utilization ratio is 20%.
A lower credit utilization ratio is generally seen as favourable by lenders because it suggests you’re not overly reliant on credit. When you close a credit account, especially one with a high credit limit, you reduce your total available credit. This can lead to a higher credit utilization ratio, potentially lowering your credit score.
Another important factor in your credit score is the average age of your credit accounts. The longer your credit history, the better, as it demonstrates a track record of managing credit responsibly. Closing an old account can shorten the average age of your accounts, potentially having a negative impact on your score.
Some people worry that having too much available credit can be seen as a risk by lenders. The fear is that lenders might think you could suddenly rack up debt. However, most lenders focus more on your actual debt levels, payment history and overall credit profile rather than the total amount of available credit.
As long as you’re using credit responsibly and not maxing out your cards, having available credit isn’t inherently negative.There may be no need to close credit if you have large amounts of available credit.
While closing credit accounts isn’t always necessary, there are situations where it might make sense:
High Annual Fees: If you have a credit card with high annual fees that you no longer use, it might be wise to close it. However, consider asking the issuer for a no-fee downgrade option first.
Temptation to Spend: If having available credit tempts you to overspend, closing an account could help you manage your finances better.
Simplifying Your Finances: If you have multiple credit accounts that you find difficult to manage, consolidating or closing some accounts could simplify your financial life.
Before you close credit accounts, you should speak to a professional first. It could be your mortgage broker who you’re working with or your financial planner. But, ensuring that you speak to someone before shutting an account will help maintain your financial health.
If you’re concerned about your credit score and want to improve your mortgage application, consider these alternatives:
Pay Down Balances: Reducing your existing balances can lower your credit utilization ratio, which can positively impact your score.
Keep Accounts Open but Inactive: You can keep your accounts open without actively using them. This maintains your available credit and the age of your credit history.
Monitor Your Credit Report: Regularly check your credit report for errors or inaccuracies that could be dragging down your score.
Use Credit Responsibly: Make on-time payments and avoid taking on unnecessary debt. Responsible credit behavior is the best way to build and maintain a strong credit profile.
While closing credit accounts might seem like a quick fix when applying for a mortgage, it’s not always the best strategy. Even if a bank suggests it, always get a second opinion!
By focusing on responsible credit use and understanding how your credit profile works, you can position yourself for the best possible mortgage terms without the need to close accounts unnecessarily.
If you’re looking for mortgage guidance, Give me a call at 250-826-3111, apply on my website or contact me through my online contact form to start the process today.
Let’s get your application off the ground.
