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Closing credit card account may do more harm than good

Published March 21, 2004

Closing a credit card account is often the first thing that comes to mind if you have gotten yourself in credit trouble or are worried that you might. It seems perfectly logical because closing an account removes a temptation to rack up new debt. However, it can be a major mistake.

Credit scoring is the reason. While paying your bills on time is the most important factor in establishing good credit, it is not the only thing that goes into determining your credit score. Your score, in turn, determines what kind of interest rate you will be offered if you apply for a mortgage or car loan and even what kind of credit card offers you will get in the mail.

One of the other factors in credit scoring is the length of your credit history. Since longer is better, it pays dividends to keep your oldest accounts open even if you do not use them.

Your credit score also takes into account the size of your debt in relationship to your available credit. The lower your debt percentage, the better. Suppose you owe $1,000 on each of two cards, each of which has a $3,000 credit limit. If you close one account and transfer the balance to the other, you still will owe $2,000, but your debt will have jumped from one-third to two-thirds of your credit limit, making you look like a more questionable credit risk.

Another credit consideration is demonstration of your ability to handle different types of accounts, such as mortgages, installment loans and credit card loans. Closing all your credit card accounts would be a mistake on that score, in addition to making it difficult for you to rent a car, book a hotel room or buy a plane ticket.

Just because an account is open does not mean that you have to use it. You can make your card inaccessible by freezing it in a block of ice in your freezer, as some people do, or eliminate temptation by cutting your card into little pieces.

Of course, sometimes more action is required. If someone has stolen your identity and opened an account in your name, that account needs to be closed.

If you had a joint account with an ex-spouse, it should be paid off and closed. Regardless of what your divorce agreement says about who is responsible for the debt, the credit card issuer can come after both of you if both names are on the account. Of course, prevention is the best solution; newlyweds would be smart to keep separate charge accounts.

To properly close an account, notify the card issuer in writing. Do it by certified mail if the matter is urgent, as it might be in a divorce. In any case, get a written confirmation of the closing or call if one does not arrive within two weeks.

Try to avoid closing an account without paying off the balance. Interest rates may be considerably higher on an account that has been closed.

In case you were wondering, closing an account on which you have been delinquent does not make the negative marks on your credit go away. However, their impact on your credit score will lessen over time whether the account is open or closed. Recent behavior is weighted most heavily.

Q. I was visiting West Virginia and won a $5,000 jackpot. No taxes were taken out by the casino. Also, I've been playing the local Lotto (Cash 3). How do I claim this on my taxes? Normally I do my own taxes, but with the added income I'm at a loss.

Gambling winnings are taxable as "other income." The $5,000 should be reported on Line 21 of Form 1040. If you itemize, losses up to the amount of your winnings can be deducted as miscellaneous itemized deductions. They are not subject to the same income limits as other miscellaneous deductions. You will need proof of your losses if your return is audited.

Q. I have a revocable living trust with my two children as beneficiaries. I believe my assets will be free of the estate tax, but will the death benefit be subject to the individual income tax?

The general rule is that an inheritance is not subject to income tax. However, if any part of an inheritance is in a tax-favored vehicle, such as an individual retirement account, retirement savings plan, annuity or savings bonds, the beneficiary will owe taxes at withdrawal just as you would if you were withdrawing the money.

- Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to or Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731.

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