Lurking among many other credit related myths is the belief that paying off credit cards may cause your credit score to decline. I continue to hear this and other related credit scoring myths from consumers that I interact with on a daily basis. In reality, when you pay off credit cards you decrease your overall utilization - your total balances vs. your total available credit - which improves your score.
In fact, utilization accounts for approximately 30% of your credit score. It is best that you keep your overall utilization below 10%. For example, if your total available credit on all credit cards is $25,000, then you want to keep your collective balance at less than $2,500. And, the lower your utilization is the better your credit score. So, the idea that paying off balances will negatively affect your score is simply not true!
However, the above scenario should not be confused with closing credit card accounts, which could have an adverse affect on your score for two important reasons. First, as discussed above, you have to consider how it will affect your utilization. Typically, closing an account will cause your utilization to increase and, as a result, your credit score to decrease. So, it is important to do the math before making a final decision. (Keep in mind how it could affect your utilization in the future as well!)
Additionally, you have to consider the age of the account. If it is one of your older credit cards, then it could also adversely affect the length of your credit history which makes up 15% of your FICO Score. Most of the time it is better to just "sock drawer" the card if you do not plan to use it anymore. That way having an account in good standing and the available credit is continuing to help your credit score.
Just be sure to remember to use the card about once per year for a small purchase, then pay in full when you get your statement. Doing so will help the account stay active and reporting as such to the three major credit bureaus. Reporting your on-time payments (preferably to all three major credit bureaus) is an effective way to boost your credit score. On a related note, it's also a good idea to check with your creditor to find out which bureaus they are reporting to.
Do you have a credit score related question or what you feel might be a myth that you'd like debunked? Please share your questions and comments by posting on our active credit forum! Also, if you don't know your credit score, be sure to check out our offers that allow you to get your credit score for free.