Are you free of credit card debt or you want to reduce the number of cards in your wallet so you're thinking about closing your account?
Before you decide to cut up your card, decide whether you're really better off canceling the card. How you use your credit is an important factor in your overall credit score, and knowing the impact of canceling cards could help you maintain a good credit score.
Pros of Closing a Credit Card
There are plenty of reasons why you would want to close a credit card account, including:
- You have too many cards to keep track of. You might have a collection of credit cards from major banks, credit issuers and retail stores, but find it's more difficult to pay them off if they all have separate due dates.
- Your cards have annual fees. As you try to save money for other financial goals, you might decide having a card with an annual fee isn't worth it because you'd rather put that money into savings or toward paying down other debt.
- The card has a high interest rate. If you notice yourself paying a high amount of interest every month, you might be tempted to switch to a card with a lower interest rate to save money.
Although the reasons above could allow you to focus on your other credit obligations, it's crucial to determine the effects of canceling these accounts on your credit score. Closing an account could lower your creditworthiness if you're not careful.
Here are reasons to avoid closing your credit card accounts:
1. Your Credit Utilization Rate Worsens
When you close a credit card, you also cancel that line of credit, which is added to your total credit amount each month. As a significant factor in your credit utilization rate, a smaller credit line total could increase your rate because your debt is a greater percentage of your total available credit and cause creditors to think you owe more money than before you dropped the account.
For example, imagine you have five credit cards that have a balance of $5,000 and a total credit availability of $20,000. Divide the balance by the limit and you get a credit card utilization rate of 25 percent. This is lower than the 30 percent maximum suggested by Credit Karma to have your credit score up with some of the strongest credit card holders.
However, if you decide to pay off the balance of one of these cards with a balance of $1,000 and a limit of $4,000 and canceled the card, you then distribute your spending on four cards instead of five. Now one card has a balance of $1,800 with a $4,500 limit instead of its usual balance of $800. This results in this card having a credit card utilization rate of 40 percent. Your overall utilization rate then increases to 31.25 percent – higher than the recommended maximum.
2. Your Credit History Age Decreases
When you decide to close a credit card account, you could see the average age of all your credit accounts decrease. According to FICO, the length of your credit history represents 15 percent of your FICO credit score. By canceling a card, you could lower your credit history age and cause your score to decline, especially if it is one of the oldest accounts on your credit.
3. Positive Information Stays on Your Credit Report
If you have a great history of making payments on your credit card on time, then closing the card might also prevent creditors from continuing to report this positive information. CreditCards.com points out that good credit information will stay on your credit report longer than negative information. By choosing to keep your card, this positive information could help your score in the long run.