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Multiple sources say that if you have several credit cards with balances, and you pay down one of them, your credit rating will take a hit if you close that card. Now I know what the stated reason is -- credit agencies factor in the ratio of your total debt to your total available credit limit, so if you close out a zero-balance credit card, your ratio of total debt to total credit limit has gone up. However, I'm arguing that it doesn't make any rational sense for them to penalize you for that.

In some cases, if A and B have the same debt but B has a lower credit limit, it's rational to give B a lower credit score. If A has a $50,000 credit limit is usually $25,000 in debt, but B has a $30,000 credit limit and is usually $25,000 in debt, then it's likely that A has some degree self-control, while B doesn't stop spending until they almost "hit a wall".

However, that's not what we're comparing. Suppose you have a credit limit of $50,000, and you've just finished paying down your debts from $40,000 to $25,000. You have two cards with $10K limits that you just paid down, and you're trying to decide whether to leave them open (be like A), or close them (be like B). Ignoring the credit rating, the rational choice is to close them -- every additional card is an additional risk of identity theft, an additional relationship to manage, an additional source of temptation, and (sometimes) an additional annual fee. But the rating agency punishes you for doing the sensible thing here. And they penalize you even though they can see your history, so they know you're someone who is paying down your cards and closing them -- as opposed to someone who started with a $30K limit and then ran up their cards until they "hit the wall".

So it makes no sense to me that a person who has paid down part of their debts, and wants to reduce their risk and fees by closing a zero-balance credit card, would be penalized for this. Am I missing something, or is this just a counterproductive rule of the rating agencies that everyone accepts because "it just is"?

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    I think credit rating agencies also look at the age of the accounts - so closing longstanding credit accounts has negative impacts in that way as well if your currently still open accounts are newer. – Magisch Jun 18 '18 at 7:22
  • @Magisch I'd heard that too, but (1) same question, really -- that sounds irrational, because whether you're closing a "new" account or "old" account should make no difference as to how responsible you are with your money; and (2) it still doesn't answer the original question, which is, if we suppose for the sake of argument that you're closing a "newer" $10K credit card after you pay it down to zero balance, why should closing that account make you look less responsible with money and drag down your credit score? – Bennett Jun 18 '18 at 7:56
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Generally, Credit ratings are automatically calculated from your current situation, and are not influenced by the sequence of actions that got you there.

You are right that a sensible action might get you (temporarily) in a situation that looks statically worse than before, but that is a minor side effect, and an automated credit rating calculation cannot easily account for that - so it doesn't.

A human might look at the sequence of actions an individual takes, and realize that there is an improvement process; but credit ratings are not given by human, they are calculated from statistical historical behavior data. Every single piece of a credit rating might or might not make sense for a specific person, but statistically, they are predicting average future payback behavior with some accuracy.

  • This is contrary to a lot of what I'd heard about credit scores, that the "sequence of actions that got you there" definitely matters. For example, old and closed accounts are still factored into your credit score for several years, aren't they? And pretty much all sources agree that the age of your cards matters -- if you have $5,000 debt on a card, it matters if you've had the card for 1 year or 10. – Bennett Jun 18 '18 at 17:30
  • @Bennett , this is not a contradiction. Age and history are very relevant; what I am saying is that the sequence is not relevant. so if you do good thing first and then a dumb thing, you might be in the same place as if you do the dumb thing first and then the good thing. The latter might show you're learning but this is ignored – Aganju Jun 18 '18 at 18:57
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    OK, but then this just boils down to my original question: Isn't it irrational that they do this? Since they know your history, and they can distinguish between someone who recently paid their debts down from $40K to $25K and then lowered their own credit to $30K, versus someone who had a $30K limit and spent $25K of it, it seems like they shouldn't treat these as the same. – Bennett Jun 19 '18 at 1:02
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    It's automated statistics. No rational mind is applied. – Aganju Jun 19 '18 at 3:00
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    Well, obviously, but they have a choice of how they write the algorithm, and that's where some rationality can be applied. – Bennett Jun 20 '18 at 5:24
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If A has a $50,000 credit limit is usually $25,000 in debt, but B has a $30,000 credit limit and is usually $25,000 in debt, then it's likely that A has some degree self-control, while B doesn't stop spending until they almost "hit a wall".

Credit rating agencies don't know your salary / income. The Credit limit is a rough indicator of the salary / income one has that can be serviced by individual; the assumption being lending institutions would have made some due diligence. So all things being equal; a person earning say 100K; A has credit limit of 50K and spend on 25K is better than B having a credit limit of 30K [implicitly assumed his salary is not 100K but less] and spending 25K.

Suppose you have a credit limit of $50,000, and you've just finished paying down your debts from $40,000 to $25,000

If you are saying someone was using revolving credit and has raked up 40K and not paid in full every month; the credit rating would already be hit badly. In such cases if a card is closed; it is not sure if this was initiated by Bank or by individual. It indicates a lack of self control.

Generally if you have multiple credit cards and are paying on time; if you close the card and this does not reduce your limit drastically; the score gets nominally impacted.

  • "So all things being equal; a person earning say 100K; A has credit limit of 50K and spend on 25K is better than B having a credit limit of 30K [implicitly assumed his salary is not 100K but less] and spending 25K." -- Ok, but in the hypothetical I'm proposing, a person had a credit limit of 50K before they lowered it themselves. But the fact that they used to have it at 50K, should be an indicator that their salary was enough to get that credit. (Admittedly this logic doesn't apply if the bank closed the person's card because the bank might know their salary went down.) – Bennett Jun 18 '18 at 8:14
  • @Bennett Lowering of Credit Limit Voluntarily by individual or forced by Bank is currently not distinguished. I guess [?] Lowering of Credit Limit Voluntarily is a recent phenomenon; maybe this will get factored in if there is some sort of indicator. I guess more and more individuals [rightly] are taking a view that even if covered by insurance / fraud protection; Credit Limit should be more in line of spending habit rather than affordability [salary benchmark]. – Dheer Jun 18 '18 at 9:06

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