When starting your personal finance repair journey, you may be tempted to close some of your credit card accounts, especially if the credit card has a negative impact on your credit, such as a late payment. Canceling a credit card if you rarely use it or have paid off the balance can feel good.
It can give you a sense of accomplishment while lightening your wallet, eliminating credit card debt and giving you one less way to spend. Additionally, even the best credit cards with all the perks can get you in a bind if you're not disciplined.
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Should you cancel your credit cards?
Generally, canceling your credit cards is a bad idea. It’s better for your credit score, in most cases, if you keep the account open. A big part of your credit score depends on the length of your credit history. If you want to keep your credit score where it is or improve it, then holding on to a credit card is a good option.
After all, a closed account doesn’t remove the account from your credit report. Your payment history and credit history length stay on your credit report for 10 years. That can be a good thing — your oldest account shows your credit history length, despite being an unused credit card, which accounts for 15% of your credit score.
The credit bureaus Experian, Equifax and Transunion use different scoring models, including FICO, to gather the information and data needed to compile your score. They calculate the amount of available credit with your balance to compute the credit utilization rate. A lower rate is better for your score.
However, if you can only meet the minimum payments and maintain a balance, your score could suffer. Before you cancel your credit card, try calling the issuer and asking them to waive their annual fee or downgrade the account or total available credit/amount of credit.
Closing credit cards can hurt your credit score
Keeping your credit cards open adds credit history to your credit profile, even if it has negative marks. It’s much better to try and remove late payments from your credit cards than close them.
Why does canceling a credit card affect your credit score?
Your credit score is largely based on how well you manage open credit accounts. Closing an account reduces the average age of the accounts in your credit report. If an account is closed, there is nothing to go off except the account history before you closed the account (which is likely bad if you felt the need to close the account). An excellent credit score indicates long-term, well-managed credit accounts.
Also, while it is true that too many open credit card (revolving) accounts can hurt your credit score, the key is to shy away from opening too many accounts and avoiding closing them. Here is the bottom line: Never close an open credit card account — it can hurt your credit score.
Credit utilization falls if you cancel
Closing credit cards hurts your credit utilization, which is the percentage of your available credit used. Lowering your credit utilization generally helps increase your credit score. About 30% of your credit score comes from credit utilization.
By canceling a card, you have less available credit to spend. If you spend the same amount on your credit cards, your credit utilization ratio also rises because you have less available credit.
Credit utilization ratio explained
Here’s an example: Suppose you have three credit cards with $10,000 each in available credit, for a total of $30,000. You use about $10,000 of that credit each month, charging about $3,333 per card. That gives you a 30% credit utilization ratio, which is about as high as you want it to go for credit scoring purposes.
Drop one of those cards, and you now have $20,000 in available credit but are still spending $10,000 per month. Your credit utilization ratio has just increased to 50%, which is extremely high. Unless you cut your spending, the ratio will remain high.
You can improve your credit utilization ratio by paying off most of your credit card balance and using your credit card less. There are also other options.
Alternatives to closing a credit card account
Since credit utilization is such a big factor in a credit score, it can make sense not to close a credit card and use other options. In addition to using a card less or not at all, you can call your credit card company and ask it to waive the annual fee.
The company’s retention department is likely interested in keeping you as a cardholder instead of canceling your card because it’s cheaper to retain a good customer than acquire a new one. They may also offer you other incentives, such as bonus points.
Change to a no-annual-fee card
Another option is to switch the card you’re considering closing to a no-annual-fee card. You’ll have the same credit limit and account number, and the account’s age won’t change on your credit report. Along with no longer paying a high annual fee, you’ll likely lose any rewards points program that your annual fee card offers — which is fine if you’re not going to use the card anyway.
Switching to a no-annual-fee card rather than closing a rewards card with a fee will avoid a hard pull on your credit account. A hard pull, or hard inquiry, occurs when a lender, such as a credit card issuer, checks your credit when you apply for a card. Too many inquiries can have a small impact on your credit score.
Limit credit card use and utilize autopay
A simple alternative to closing a credit card is to leave it at home and not use it much. Store it somewhere safe, and use it a few times a year to avoid cancellation for inactivity. A small recurring charge should be enough to keep it active and avoid automatic cancellation for lack of use.
It may not be necessary, and you can ask your credit card company about it. You may also want to set up automatic payments so you don't forget your bill for the rarely used card.
Closing a credit card won’t be the start of your financial downfall, but doing so does have consequences, and it could hurt your credit score temporarily. This penalty may be worthwhile if an extra credit card is too tempting to avoid using.
Should I reopen my credit card accounts?
Another technique you can try if you have already closed a credit card account is to contact the creditor and ask if they will consider reopening the account. You can be certain they will pull your credit report, so this usually only works if you have shown some recent improvement.
Important things to remember about canceling credit cards
- Never close credit card accounts that are in good standing.
- Avoid bad credit by not opening too many new card accounts (two or three credit cards are plenty).
- If you can’t control your spending, it’s better to throw away the credit card than close the account or search for a lower interest rate balance transfer to help control your credit debt.
- Attempt to reopen closed credit card accounts by contacting the creditor after showing you are trustworthy.
- If the card you have is obsolete, try canceling the card and opening a rewards credit card, such as American Express, to capitalize on the perks for traveling.
- To cancel a credit card, contact the issuer, and give your name, phone number, credit account number and address; then, state you would like the card to be closed “at the consumer's request.”
Disclaimer: This story was originally published on May 3, 2022, on BetterCreditBlog.org. For more information on closing credit card accounts please visit: https://money.com/cancel-credit-card-credit-score/