It is a common misconception that closing a credit card account will improve your credit score. So, if you are trying to repair bad credit, it is not necessarily the way to do so. While closing a card may help prevent you from overspending, it can actually cause your credit score to decrease. Sometimes, it may still be in your best interest to cancel a card, but there is a lot to consider before you make that decision.
Why closing a card can lower your score
When you close a credit card, you are at risk of increasing your credit utilization ratio – the amount of money you spend in relation to the amount of credit available to you. You want a low credit utilization ratio, as lenders want to see that you are not nearing your limit every month. Closing a card means reducing your overall credit limit. Unless you seriously slow down your spending, your credit utilization ratio will probably grow. This is important, as FICO uses your credit utilization ratio as a significant factor in determining your credit score. CreditCards.com suggested trying to raise your credit limit on a card you’re keeping open if you do decide to close an account.
Closing a card can also hurt your score in the long-term. Once an account is closed, your history doesn’t disappear right away. Any positive information associated with it will remain on your credit report for 10 years, and any negative information associated with it will be eliminated after 7 years. It may be nice to lose that negative information, but when you lose that positive stuff you are losing a significant portion of good credit history. FICO’s credit scoring model rewards those with long history, so it could hurt your score to lose some of that history a decade later. According to U.S. News and World Report, those with a longer credit history are less likely to see a significant drop in their scores from closing a credit card. Young people are at a greater risk.
When to close a card
Rod Griffin, the director of public education with Experian, one of the three major credit bureaus, told CreditCards.com that consumers with good credit scores wouldn’t see a large or lasting effect from closing a credit card. So, if a card is costing you money due to exorbitant annual fees or interest rates, it may be a good idea to close it.
If you do decide to cancel a card, make sure to follow up an online or phone cancelation with a certified letter and to request a confirmation letter in return. Be patient, though. CreditCards.com said it could take over a month for the cancelation to process.
When not to close a card
Lexington Law Firm recommends keeping your cards open if you are in the market for a loan, as you will want the highest possible credit score at that time. In addition, it is not necessarily a good idea to close a credit card just because you never use it. If the card doesn’t have an annual fee or high interest rates, you might as well keep it open. It may come in handy, and a zero balance card won’t hurt your score. However, sometimes the credit bureaus will stop reporting an unused card, so it might be best to charge something small on it once a month to make sure it remains factored into your payment history.