Some debt-laden consumers go to extremes to let their credit cards cool off. Quite literally. Some exile their cards in an icy "lock box" in their freezer. It's believed that in the time it takes the ice to melt, the urge to spend will have passed. That's usually a fix for someone who can't easily control their charging. But what about those consumers who put a figurative freeze on credit card debt?
[See 10 Signs You Shop Too Much.]
Some consumers routinely let their credit cards gather dust. They're comfortable walking around with cash or they use debit cards, saving credit accounts for emergencies and the occasional plane ticket or hotel room. Their resolve is admirable, as allowing revolving balances to swell, often at much higher interest rates than on other loans, can strain household finances. High balances jeopardize the high credit ratings needed to secure attractive financing on life's big demands, like a home purchase.
But as anyone who's ever tried to decode their credit report knows, all credit cards are not created equal.
For starters, having a respectable amount of credit history is important. Accounts that carry modest balances and robust upside borrowing limits will earn favorable points. That's because the consumer has not only proven their reputation for paying their bills, they're viewed as having credit wiggle room in a financial pinch, which will help them keep up with their bills.
But one of the first distinctions the consumer (and the lender, for that matter) should make is to determine if a credit account is active or inactive. Here's where card-use frequency can really make a difference.
If a consumer carries no balance and pays only a small or nonexistent annual fee, the issuing company makes no money. When a consumer uses the card and pays it off before interest kicks in, the issuer still collects an interchange or "swipe" fee from merchants. No balance and no fees mean the issuer is paying to maintain the account and it's generating marketing expenses as it tries to woo the consumer with increased limits or other promotions. An issuer will do this for some time, but eventually consumer inaction will cost the issuer too much and it will close the account (If an issuer cancels an account due to inactivity, notification to the cardholder isn't required, according to the Equal Credit Opportunity Act.) As a result, the approved but unused credit limits that worked to drive up a credit score disappear.
Particularly damaging is when consumers close accounts they've paid off even while they continue to work down what's owed on their remaining high-balance card or cards.
Here's how it works: Fewer accounts on record and a lower overall approved borrowing limit pushes up the consumer's revolving utilization percentage. Utilization reflects the debt-to-credit limit ratio on revolving accounts.
A spike in this reading can be a drag on the credit score. Granted, utilization is only one figure used to calculate the amounts-owed portion of a credit score, but it's an important one. Overall, the amounts-owed factor counts for about 30 percent of a score, according to FICO, one of the original credit-scoring companies. (The company name has become synonymous with the score itself; credit scores are often called FICO scores. They're issued through consumer reporting agencies, including Equifax, Experian, and TransUnion.)
There's a solution, but one that shouldn't be treated recklessly. Simply use all cards from time to time to keep them active. That's right, blow of the dust. Just try to pay that balance before the interest kicks in; making minimum payments can get a little too comfortable.
Sometimes consumers tire of a little-used card. They don't like the marketing solicitations. They worry about misplacing the card or having too many account numbers vulnerable to theft.
But closing credit card accounts should be given careful thought. If bad credit marks on a report go away in around seven years, so do strong track records. That means open accounts are necessary for feeding a credit score over time. And, hey, if you don't trust yourself, there's always the freezer.