Know the rules in Crazy Credit Town

WASHINGTON, D.C. >> The systems used to score your credit behavior can be confusing and counterintuitive. Just think about this: To get a good credit score, you have to use debt. But using debt means you lose some of your financial freedom because you owe money.

I call this Crazy Credit Town. Yet this is a place many Americans find themselves.

I asked representatives from the three major credit bureaus — Equifax, Experian, TransUnion and FICO, the company that created the credit-scoring model used by most lenders, to address some common credit misconceptions. I’ll walk you through their responses here and in future columns.

Let’s start with two credit myths about closing an account.

• Closing a credit account will negatively impact your credit score. That’s not necessarily true.

Rod Griffin, director of public education at Experian: “When you close a credit card account with a zero balance, you lose the available limit for that account. If you are carrying balances on other cards, that causes your overall balance-to-limit ratio, called your ‘utilization rate,’ to increase. An increase in the utilization rate is a sign of risk, which will cause credit scores to dip a bit initially. However, if everything else is good in your credit history and remains positive, scores typically bounce back up within a few billing cycles because it becomes clear you didn’t suddenly take on a lot of new debt.”

But, Griffin adds: “You probably shouldn’t close the account if you are planning to apply for new credit within the next three to six months, just to be sure things remain stable.”

Heather Battison, vice president at TransUnion: Since your credit-utilization rate is a major component of your score, consider whether any account you want to close represents a small or large portion of your available credit. “Closing the account could have little to no impact on the score,” says Battison. “But if the account provides a large portion of the available credit, closing it may have a negative impact on the score.”

To get a good credit score, you have to use debt. But using debt means you lose some of your financial freedom because you owe money.

Can Arkali, principal scientist at FICO: “If an individual has a balance on her or his remaining cards, it is likely that such a balance will now represent a higher percentage of their available credit. This would increase the person’s credit utilization and may result in a lower FICO score. In general, if a person has established a lengthy history of responsible credit management by keeping their credit card balances low and consistently paying all their bills on time, the impact of a card closure can be minimal and shortlived.”

Jason Flemish, vice president of global customer care at Equifax: “Lenders and creditors look at this information on your credit report in order to come to a lending decision — to see not only credit limits that have been extended in the past, but also how a consumer may have handled a high credit limit.”

• You shouldn’t close an older account because you’ll immediately lose your positive credit history. That’s false.

Arkali, FICO: “As long as the closed account is reported to the credit bureaus by the lender, it will be considered by the FICO score when determining the length of a person’s credit history.”

Griffin, Experian: “A closed account with no negative history remains in the credit report for 10 years from the date it was closed. Closed accounts with late payment history remain seven years from the original delinquency date. Positive information remains longer than negative information, which helps people build a strong credit history and recover more quickly if they’ve had financial challenges.”

Still not sure what to do?

Griffin offered what I thought was a good crib sheet for closing an account:

• If you have a good credit history and credit rating: Don’t be concerned about closing an account you don’t want. Your score may dip a bit but it’ll bounce back quick enough.

• If you’ll be applying for credit in the next three to six months: Don’t close accounts. But be sure to pay them on time. Your score will also benefit from paying balances off every month or at least reducing what you owe.

• If you have a bad credit history and/or are maxed out: Whether your score drops or not, you may need to get rid of the temptation.

“Don’t let the credit score be the only factor in making the decision to close an account,” Griffin said. “Too often people are paralyzed by a credit score and they make a bad decision for their overall financial credit.”

If you want to stay and play in Crazy Credit Town, it’s important that you know the rules.