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by Center for Personal Finance editors


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Credit card companies are imposing new and creative fees as they react to the credit-card reform law. As a consequence, like many Americans, you may be afraid you'll get hit with an inactivity fee for not using a credit card. But closing that account could hurt your credit score. What to do?

It's a tough call but, if you're careful, you can close the cards you don't use with little effect on your credit score. The best strategy is to pay down all your balances before closing any credit-card accounts.

Here's why: Your credit-utilization ratio-the total of your card balances divided by the total credit limit on all of your cards-traditionally has been the second-most influential factor in your credit score. Since the three credit bureaus rolled out a new formula to calculate scores in 2009, that credit-utilization ratio now may be the most influential factor in your credit score.

If you close cards you haven't used in awhile without paying down the others, your total balance due becomes a higher percentage of your new, smaller, overall limit. Your credit-utilization ratio goes up. The best credit utilization is 0%; a good utilization ratio is less than 30%.

And it doesn't matter if you pay your credit card balances in full each month. What counts in credit scoring is the amount you've charged that month, because you never know on which day the score is calculated. Your best strategy: Pay down your balances before closing any card accounts to minimize the impact on your credit score.

Be on the lookout for these five factors that carry the most weight in affecting your credit score:

1.    Your overall revolving debt.  This is the amount of credit card debt you owe in relation to your available balances, both on an individual account basis and overall. Historically it weighed a little less than your payment history (30%) in determining your credit score. Now it counts the same or even more. Contrary to popular belief, it is better to owe a smaller amount on several cards than to max one card to its limit. A good long-term approach is to keep your balances between 10% and 35% of your available credit, and definitely at 10% in the three-to-six month period before you apply for any sizable loan.

2.    Your payment history. Before 2009, it weighed the most (35%) in determining your credit score. Your payment history is still a big factor, but may weigh less than overall debt. Paying before the due date can mean the difference between an average and an exceptional credit score. By the way, your most recent history is more important than what you did a few years ago.

3.    The length of your credit history. Raise your score by keeping accounts open for more than seven years. The length of your credit history accounts for about 15% of your credit score. Instead of closing accounts, work toward paying them off and then let the accounts remain open. Use them for small purchases that you pay off each month.

4.    The number of inquiries and new debt in your records. Inquiries and new debt account for about 10% of your score. Fortunately, all mortgage inquiries within 30 days are grouped as one inquiry. Auto inquiries similarly have a 14-day limit. Since the formula changed in 2009, inquiries have less of an effect.

5.    The kind of debt you incur. It's still true that 10% of your score is based on the kind of debt you incur: installment debt (auto loans, for example) vs. revolving debt (credit cards). Credit bureaus look more favorably on installment debt than revolving debt. What's new since 2009? You get points for successfully managing multiple types of debt (mortgage, auto loan, and credit cards).

Published May 28, 2010

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