When you’re organizing your personal finances, closing a credit card account that you haven’t used for a while may seem like a good idea. That’s one less credit account you’ll have to worry about, so it might seem easier to simply close the account and stick with other credit cards you use more often.
Don’t be too quick to close that older credit card, though. Having a long-time credit card account on your credit report works in your favor in a few ways that you may not realize.
What happens when I close a credit card account?
Closing unused credit cards may feel like spring cleaning your personal finances because it seems easier to manage and organize your finances with fewer credit accounts. However, in many cases, an old credit card account may not be much trouble at all, but you may feel uncomfortable knowing that it’s out there and could potentially be stolen or used for fraudulent transactions.
If a credit card you currently use has a high balance, you may think closing the account will keep you from maxing out the card or getting in debt even deeper. However, closing a credit card is generally a bad idea for these reasons.
Your credit utilization rate increases
When it comes to your credit score, your credit utilization ratio makes up about 30 percent of the FICO score used by credit card companies and lenders to determine creditworthiness. It’s easy to calculate your credit utilization ratio, which is the percentage of revolving debt you have in relation to your amount of available credit.
For example, if your credit card limits total $10,000 and your credit card debt is $6,000, divide the total balance by the total of your credit limit(s) to find your credit utilization rate. In this scenario, your credit utilization ratio would be 60 percent. That’s way too high.
Personal finance experts recommend keeping your credit utilization rate under 30 percent to keep the ratio from negatively affecting your credit score. That’s where closing a credit card — and eliminating the card’s accompanying credit limit — can lower your credit score.
If your credit card is maxed out and you’ll gain more self-control by closing the account, hold off on getting rid of that account. If you close the credit card, that action will lower your amount of available credit, which will raise your credit utilization ratio, lowering your credit score.
Instead of closing the credit card, focus on halting new transactions and paying down that card’s debt to lower your credit utilization rate and raise your credit score.
The credit bureaus will shorten your credit history and age.
While you might be tempted to trim the information on your credit report to clean it up, sort of like getting a haircut, that’s generally a bad idea. Older accounts without negative payment history are great for your credit score. That’s because length of credit history makes up around 15 percent of your credit score.
So older accounts work in your favor, showing creditors that you have experience managing credit card and other debt responsibly. After you don’t use a credit card for a long time, you may get a notice from the credit card issuer that you must use the card by a certain date. for the account to remain open or for your credit limit to remain the same.
If that happens, charge a purchase less than $10 or $20 to the credit card and then pay it off immediately to avoid interest or risk carrying another balance.
Does closing a credit card hurt your credit
Question: I have transferred all my credit card debt to a single no-interest card for 18 months. I have five other credit cards, and now all the other credit card companies are increasing the limits on the cards I just paid off. Which is better for my credit score: Cancel them? Hold onto them? Or charge a little and pay them off each month? I really don’t want to use them.
— Kim in Pennsylvania
Howard Dvorkin answers…
Here’s the short, cryptic answer: The best thing for your credit score might not be the best thing for you.
Your credit score is based on five factors. One of those is called “length of credit history,” and it comprises 15 percent of your score.
If those five still-open credit cards have been in your possession for years, then they’re actually boosting your credit score. Here’s the problem, though: You need to keep using them for that 15 percent to keep kicking in.
That means you need to make small charges every once in a while — and then pay them off in full. How often? Once a month to be safe, once a quarter on the outside.
Of course, if this poses too much temptation to once again run up your balances, the safe bet is to close those cards. Payment history is the biggest chunk of your credit score, accounting for 35 percent, so if you’re late on even a few payments, it will overshadow the 15 percent benefit you’re receiving.
Credit utilization is the second-largest chunk of your credit score, accounting for 30 percent. It refers to how much you owe compared to how much you can borrow. Therefore, if you have almost maxed out five credit cards with $10,000 of available credit, your credit score will suffer significantly.
So as you can see, 65 percent of your credit score is determined by paying your bills on time, and keeping your balances low. That’s why it’s so hard to tell you if closing five mostly inactive credit cards is good or bad for you.
There’s one other factor of your credit score I even hesitate to mention, because it’s the vaguest and one of the smallest slivers of the pie. It’s called credit mix, and it represents 10 percent of your score. In plain English, this means you have a variety of different credit lines.
Why is this important to lenders? It proves to them that you can pay back all different kinds of debt. In the case of these five credit cards, closing them would reduce the diversity of the debt you’re holding. So that’s another ding on the credit score.
Money in a minute: What if your credit score was a pie?
If you picture your credit score in a pie, it’s divided into five slices. But each slide is not the same size. The largest – a third of the entire size of the pie – is called payment history. That means, do you pay your bills on time? The next biggest slice is just another a third, it’s called credit utilization. That means how much of your available credit have you spent. As you can see, that’s more than two-thirds of the pie. Three other slices are really small.
Length of credit history is only 15 percent. And at 10 percent each are credit mix and new credit. What’s this prove? Focus most on the two biggest slices and your credit score will be easy as pie.
Should you close credit cards you don’t use?
If you’ve soldiered on through this long explanation, then you might see the wisdom in this advice…
- Completely pay off the no-interest card within 18 months (or face sky-high interest rates).
- Keep that card and 1-2 of the oldest cards you have.
- Make small charges to each, and pay them off in full each month.
- Close the other cards and don’t look back.
Within a few months, you should see your credit score creep up. Over many more months, if you keep paying off your cards each month, you’ll see it jump. Why? Lenders will consider you an excellent customer because you have a history of paying low balances on time and have a few very old cards. You can’t beat that.
What’s the best strategy to cancel a credit card?
“My fiancé and I plan to get married as soon as this pandemic ends. Luckily, we both still have jobs, although I’ve been furloughed one week out of the month. We’re trying to pare down our financial lives to the bare necessities, so I want to get rid of at least some of our credit cards.
I have a Visa and Discover Card I’ve had forever, and four store cards that I only got because there was an initial discount. My fiancé has nine cards, and he’s always trying to use the ones that give him the most rewards. Unfortunately, he has so many he sometimes forgets to pay one, and between the late fees and the annual fees he’s paying, I’m not sure he’s really earning anything.
He doesn’t want to close any of our cards because he says it will destroy our credit score. I’d rather our score drop than keep cards we can’t keep track of in a bad economy. I don’t want to argue about this, so what do you think? Should we close some of our cards and if so, which ones are the best to close?”
– Victoria in Texas
Laura Adams, author, and host of the Money Girl podcast responds…
Having credit cards and using them responsibly is one of the best ways to build excellent credit. High credit scores help your financial life in a variety of ways, including:
- Qualifying for loans on a home, car, education, or other personal needs at competitive interest rates.
- Getting the lowest credit card interest rates and best promotional offers.
- Reducing your insurance premiums (in most states) for auto, home, and life policies.
- Getting approved to rent an apartment or home.
- Cutting your security deposits on different types of utilities.
- Increasing your chances of getting a job.
Once you have credit cards, it’s critical to know when or if you should cancel them. They’re financial tools that come with pros and cons you must weigh carefully.
Deciding to keep or cancel
The main advantage of keeping credit cards open is that you’ll have the highest available credit. That could be a lifesaver if you experience financial hardship and run out of income or savings. But another reason to hold on to available credit is that it’s a part of your credit utilization ratio. It is one of the most significant factors in how credit scores are calculated, counting as 30%. Canceling credit cards causes your utilization ratio to skyrocket and your credit scores to drop.
Credit utilization is calculated by dividing your total account balances by your total credit limits. For example, if you have a credit card with a balance of $1,000 and a credit limit of $2,000, your utilization ratio is 50% ($1,000 / $2,000 = 0.50).
Your ratio is calculated per credit card and as a total of all your cards. Therefore, keeping a card open, even when your balance is zero, boosts your credit scores. The more available credit you have in your name, the better it is for your credit scores.
The ideal utilization ratio is 20% or lower because it shows that you’re using credit responsibly. Again, this should be your target per card and as an aggregate of all your cards.
Whether taking a hit to your credit is worthwhile depends on your financial goals.
When to close a credit card account
Even with all the benefits of keeping a credit card account open, there are a couple of scenarios where closing the account may be a better option.
Credit cards can be a great tool for building credit and managing your finances, but it’s important to know when it’s time to cancel one. Here are some do’s and don’ts to keep in mind when deciding whether to cancel a credit card:
- Pay off any outstanding balance on the card before canceling it.
- Notify the issuer of your intention to cancel the card.
- Consider lowering the credit limit on the card instead of canceling it.
- Use the card occasionally for small purchases to keep it active.
- Transfer the balance to a new card with a lower interest rate or better terms, if possible.
- Keep the card open if it has no annual fee and a long credit history.
- Understand how canceling a card could impact your credit score.
- Review your credit report to make sure the card is reported as “closed by consumer” rather than “closed by creditor.”
- Dispose of the card properly to protect against identity theft.
- Check your credit report to ensure the canceled card is reported accurately.
- Cancel a card with a high credit limit, as this could negatively impact your credit utilization ratio.
- Close multiple cards at once, as this could harm your credit utilization ratio and credit age.
- Cancel your oldest card, as this could lower the average age of your credit accounts and harm your credit score.
- Cancel a card that still has a balance on it, as this could hurt your credit utilization ratio.
- Cancel a card if you’re planning to apply for a loan or credit in the near future, as it could negatively impact your credit score.
Remember, the decision to cancel a credit card should be made carefully and thoughtfully. By following these do’s and don’ts, you can make the best decision for your financial situation. If you have any questions or concerns, don’t hesitate to reach out to me for guidance.
How to cancel a credit card to minimize potential damage
If you decide to simplify your life by closing one or more credit cards, use the following tips:
- Cancel cards slowly over time, such as no more than one card every six months.
- Cancel cards with the lowest credit limits first, so they impact your utilization ratio the least.
- Cancel cards that you’ve owned the least amount of time first.
I don’t recommend keeping cards that you’re not using responsibly. Closing them and taking a hit to your credit might prevent more significant financial problems. You’re the only one who can weigh the pros and cons of having cards.
When you and a spouse or partner can’t agree on keeping or closing credit cards, you might make a comprise. For instance, you could pay off a card to avoid potential late fees but keep it active to maintain the available credit. Or you could close one card per year using the tips above, so it has as little impact on your credit scores as possible.
Generally, however, the more credit accounts you have with a long credit history, the better.