Thinking about closing that credit card you never use? If so, your credit may take a hit.
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.
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What happens when I close a credit card account?
Closing unused credit cards can feel a lot like spring cleaning your personal finances. After all, the fewer credit accounts you have, the easier it seems to manage and organize your finances. In many cases, an old credit card account may not be much trouble at all, but you just don’t like knowing it’s out there to be possibly 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.
Older accounts are good for credit history
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.
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. For example, if you’re paying a high annual fee for a card you never use, closing the account can be a good idea.
You may also want to close a credit card that has you and a spouse as joint cardholders if you’re going through a divorce. Generally, however, the more credit accounts you have with a lengthy credit history, the better.
Published by Debt.com, LLC