How does holding onto an active but un-used credit card affect your ability to get a loan?

Question

I was debating with my friend about my old credit card.

His view is that holding onto an unused credit card is bad for my credit b/c it will count as potential money I can borrow in an instant and will impact my ability to get a loan much harder (e.g. John Doe you have good credit but you already have an empty credit card that can borrow 500k I'm not giving you a loan for 400k)

My view is that an active credit card not being used is a sign of responsibility (not spending every penny I can get my hands on) and would increase my credit score over time.

Question: To have the best chance of getting a loan in the future is it better to cancel unused cards or keep them?

Note: I know both views are not necessarily mutually exclusive and can both be right or wrong.

Answer 1

Underwriting is not universal. There are generalities and various "common knowledge" related to credit scores.

In general, the lower your balance relative to your available credit (known as credit utilization) the better your score. There is the obvious path to low utilization, and that is maintaining a low balance. The other route is pushing up your available limit.

The blind spot of credit score is income. Your credit score has no way of measuring that you have available credit equal to your annual income, meaning you could easily dig a debt hole that would be extremely difficult to climb out of.

When you go to a bank for a loan, the underwriters look at you in a more holistic manner. Credit score is a reasonably good initial low resolution filter. If you can't pay your minimums and have a credit score of 550 you're probably a bad risk. But a credit score of 750 doesn't mean you are necessarily a good risk. A "good" score just indicates that you are generally conservative enough in your assumption of credit to keep everything within your ability to make minimum payments consistently. BUT, when you go through underwriting, they're going to look at your income, your employment, your employment history, sometimes your assets, etc.

There are some pretty highly commoditized loans like car loans by manufacturer subsidiary lenders. They're really just taking employment information to have somewhere to look for the car if they need to repossess it. Mortgages got like this in to the runup of the 2008 crisis and lenders have tightened up, generally, as a result. Stated income and no employment history generally won't cut it regardless of your credit score.

Is an unused credit card good for your credit score? Generally, yes.

If your total available credit is too high relative to your income could that negatively impact your underwriting outcome on a loan? Yes.

Most of all, remember to arrange your finances in a way that makes sense for you. The general guidelines for attaining a "good" credit score should really be viewed as the pitfalls to avoid. First and foremost, don't make late payments, don't max out your credit card(s), etc. Don't go get a store credit card because the internet said a mix of credit is good for your credit score or second guess paying off a loan early because it might have some impact on your score.

If you have $50,000 of available credit with $5,000 appearing as a balance. you have a 10% utilization. If you cancel one of the cards that has a $10,000 limit your utilization will change to 12.5%. Is that going to change your score? MAYBE. Is it going to matter? Probably not. Maybe your score goes from 750 to 740, who cares.

"Never cancel a credit card" as a blanket statement is bad advice and it's written all over the internet. Mostly perpetuated by people who also don't realize "department store cards" are all but extinct and have been replaced by co-branded credit cards.

Answer 2

Having old credit lines is good for your credit score, and unused but available credit is also good as it lowers your utilization. So most likely, closing this account would hurt your ability to get a loan.

If it was one of many cards and not one of your oldest, then the impact could be negligible. The down-side of keeping the account open is that it's one more thing to keep track of (periodically check for fraudulent charges), and for some people available credit entices them to spend more than they otherwise would.

The best thing for loan approval would be keeping it open and using it from time to time, maybe use it to pay some monthly bills just to avoid having the bank closing it due to inactivity.

Answer 3

As this question is tagged Canada I will answer it from my recent experience.

I have heard this reasoning quite a few times and at all point I was skeptical since everything I read on the web told otherwise.

Recently I took out a loan to buy used car. When talking with the financing lady she told me I had an excellent score 770 at the time but I had a lot of available credit via credit car (~12.5k) with only ~2k used. This hurt me since I had to take insurance disability (not sure if this is the right term, they make payment if i'm disabled for any reason) because the bank were worried I would have trouble paying all my cards + the car if I was to max them while been disabled. It was kind of funny since the payment for the car were less than what we used to pay on the previous car and I had the same credit cards and limit back than.

So my recent experience says that yes it can hurt your chances of securing financing in some cases. For reference the total of my credit cards limit is a bit more than 25% of my annual salary.

Answer 4

They're going to look to see what your credit line is, and how much of it you've used. If you have a lot of unused credit, that will work in your favor, not against you...On the other hand, if you pay off a credit card right before you apply for a house or a car loan, expect them to be suspicious and ask for extra validation about where that money came from.

Having a lot of credit cards only works against you if you have a history of missing payments, are carrying a lot of debt, etc. Otherwise it's fine.