Today’s funding tip is a little counter-intuitive, because of some of the so-called financial gurus out there like Dave Ramsey or Suze Orman are saying. On of the biggest things they advise people to do is avoiding credit card debt.
This is very good information when referring to going into credit card debt for a vacation, purchasing new clothes or buying that huge big screen TV. When referring to those type of credit card usages, I 100% agree with Dave Ramsey and Suze Orman. However, they too often advise people to take one step further and actually close their credit card accounts which is a huge mistake!
First off, you can use credit cards to make you a lot of money. They are a great resource for money when you are starting a new business venture and building a credit. The money you spend towards a business hopefully will help you pay off the credit cards and make more money in the future and it isn’t a long gone expense like taking a vacation to Hawaii.
When we start talking about credit cards there is this negative connotation with people. The truth is that a lot of entrepreneurs and business owners get bad advice with credit cards. They are usually told that they all need to close all their credit card accounts which will be damaging to their credit score.
I want to share a story that walks you through what happens when you close credit card accounts. We had a client who lived in Florida. She was in her late 50’s and she wanted to start a transportation business. Her business would help transport people, that needed to go to the hospital on a regular basis and didn’t have other methods to get there.
They had a great idea and a great business concept. They also had good credit and a few established credit card accounts. Those credit card accounts had balances of about twenty thousand dollars, that they had used to get the business going. However, they had received some bad advice from a guy like Dave Ramsey or Suze Orman who said that credit cards are evil and you should close every account you have. They followed this bad advice and closed all of these credit card accounts.
To understand why this was bad advice, you first need to know what happens when you close a credit card. When you close a credit card accounts it directly affects your credit score. 35% of your credit score is made up of what is called “credit utilization”.
Credit utilization is your ability to access and use any type of credit. To get more points on your credit score under “credit utilization,” you need to show available credit. If you don’t have any available credit showing up on your credit score from credit cards or other lines of credit, guess what happens to your score: it plummets.
In addition to lowering your score in “credit utilization”, you also lower your score in “credit history”. Credit history accounts for 15% of you credit score. Credit history is the length that you have accounts open, the longer the better. When you’ve had an account open with a bank for the past 10 years, you are a lot less risky to them. However, when you close your credit card accounts, your average age of accounts goes down, which affects the “credit history” portion of your credit score.
When you start closing your credit card accounts you will directly affect these two portions of your credit score, causing your score to dive bomb.
These good people in Florida, that I mentioned earlier, had their credit score drop by 40 points overnight. They went from a 700 to a 660. Even worse, they were now auto-declined from banks because they had really very high utilization rates on their credit cards. This can happen to anyone. Even if you don’t have major balances on your credit cards, once you close those accounts the same thing will happen. Your score goes down.
One of the worst things you can do is close a credit card account, especially if it is a major one with access to lots of capital.It’s one thing to cancel that very expensive furniture store credit cards or an expensive retail store card, but if it’s one your high limit credit cards that you can use to buy anything from any store, you need to keep those open.
If you’re worried that you’re not disciplined enough to keep credit card accounts open, then cut up the actual credit card, throw it away, but don’t close the account. If you close the account, your credit will be damaged. With a low score, you won’t have an easy time getting funding to grow your business. It’s going to be problematic. (if you do have a low score go to www.720fico.com to help fix your credit)
One of the most important tips you won’t hear a lot is, never close a credit card account. This is one will strategy to help your build your credit score. If you have other friends and family members that have heard advice to close their credit card accounts, which they probably have, let them know what is going to happen if they close these accounts.
By using this one tip, you will keep your credit score a lot higher by directly influencing the “credit utilization” and “credit history” part of your credit score which can give you access to a lot more capital, and lower interest rates in the future. Of course, be responsible with your credit cards but keep them open and your credit score will be much better.
Have a happy and prosperous week!