If you’re considering closing a credit card account, you’d better thank your lucky stars you just found this article. We’re here to tell you to wait, and why.
Maybe the fees are outrageous. Maybe you use the Amazon credit card to shop online too often. Maybe you’re among the many people who wrongly believe that cancelling a credit card will increase credit score. Regardless of why you want to cut that plastic thing in half, there’s much to consider before doing so. As a solitary act, canceling a card won’t affect your score. However, the decisions you make afterward could either raise or lower that precious number.
Let’s start with a pro tip: closing a credit account will, again, never increase your credit score. This is true regardless of balance, or lack of. Closing an account could, again, lower your credit score – especially if you have an outstanding balance. So, listen up and read this article before cutting that card up.
Cut the Card, Affect the Ratio…
One of the five main factors of a credit score, (more on this later), is something called credit utilization ratio. It determines 30% of a credit score and cancelling a credit card will affect it. Here’s the formula:
[Total Balance on all Credit Cards ÷ Total Credit Limit on all Credit Cards] X 100
Whatever number you end up with is the percentage of your limit that you are currently using. Here’s another pro-tip… Experts suggest trying to keep your credit utilization ratio under 30% to maintain good credit.
Both open and closed accounts are considered in determining the credit score. This is why cancelling a credit card with an outstanding balance could hurt your score. Let’s say you have three credit cards. Card 1 has a balance of $400, card 2 has a balance of $200, and card 3 has a balance of $500. Each of them has a limit of $1,000. Now, at this point, saving you some math, the credit utilization ratio is 36.7% which is decent for the average American, but could still be better.
If you cancel card 3, your total balance on all cards stays at $1,100 but your credit limit drops from $3k to $2k, which increases your credit utilization ratio to 55%. So, if this scenario is at all similar to yours, the best move is to lower your overall balance as much as possible before canceling a card. Or, if applicable and affordable, boost your limit on either card 1 or 2 to maintain a good ratio.
The bottom line is that potential lenders and/or investors will look at both open and closed accounts, especially when it comes to credit utilization ratio. So, if you want to cancel a card, do the math, find out what your ratio is, and determine how it will be affected.
What Makes up a Credit Score?
Okay. So now you know how to maintain (and/or possibly increase) 30% of your credit score utilizing a credit utilization ratio. What about the other seventy percent? Good question. Closing a credit card account most greatly affects the credit utilization ratio out of the five main factors. Yet the other four factors are affected as well, albeit less directly. Here’s a close-up glance at who determines a credit score, how it’s determined, and how the cancellation of a credit card can affect each factor.
There are three national credit bureaus and therefore three providers of credit scores: Equifax, Experian, and TransUnion. In 1989, something called the FICO score was introduced, which, according to Wikipedia, “…is used by the vast majority of banks and credit grantors and is based on consumer credit files of the three national credit bureaus.” Now, here are the five determining factors of a credit score, and how card cancellation affects them:
35% of your credit score is determined by your payment history, the largest percentage of the five factors. This is why paying off your debts, in full and on time, is critical. It’s only logical that the largest component of a credit score would be determined by payment history. However, it’s also common knowledge that the average American struggles to make every owed payment on time and in full.
Before cancelling a credit card, be sure that you can continue to make all payments on time. This includes payment from the card you’re canceling if it has a balance, as well as payments due from all other accounts. Even one missed payment can lower a credit score!
Credit Utilization Ratio
As mentioned, this is 30% of your credit score. Also mentioned was the fact that experts agree on 30% or under is a good credit utilization ratio. Here’s the scary aspect of it… According to Rod Griffin, director of public education for Experian, “The 30% level is not a target, but rather is a maximum limit. Exceeding that level will have a significantly negative impact on credit scores. The lower a person’s utilization rate, the better from a scoring standpoint.”
So, as a reminder that can never be given too often, make sure canceling your card won’t negatively affect your ratio. Sometimes the amount of money saved can make closing a credit account worth it, even if it affects your credit score a little. Speak with a financial advisor about the pros and cons of this type of situation.
Length of Credit History
Your credit history is born the very first time a credit account is opened in your name. Yours most recently opened line of credit marks the tail end of your (current) credit history. A total of 15% of your score is determined by the length of this history. Long and healthy credit history is most desirable to lenders.
However, cancelling your oldest credit card does not shorten your credit history. If the account is still on your credit report, it will affect your credit score. Zero-balance and inactive credit card histories will eventually be removed from your credit report, usually after ten years. But, when it comes to exactly how long this could take, not only do each of the credit bureaus differ, but individual credit scores do as well.
Therefore, if you want to cancel your old credit card that’s been laying around forever, make sure it has a zero balance, and ideally make sure its limit isn’t still being factored into your score.
Ideally, you want to leave gaps of time between lines of credit that you have opened. For example, a lender might see it as negative if you have opened multiple lines of credit over a short period. This could come off as financial desperation, or at least money being spent unwisely. 10% of your credit score is determined by the length of time between lines of credit.
Cancelling a credit card will end one of your lines of credit. Just try to avoid opening a different line of credit around the time of cancellation. This does not include debt consolidation, which is a different ballgame. We are suggesting that you don’t cancel one card just to open another. This can lower your credit score not just using credit lines, but also by credit utilization ratio.
We realize things are getting complicated. You should establish credit, but not that often and not without perfect payment. You should have a good mix of credit lines, but have time in between establishing them. The best advice is to make timely payments and make them in full. As long as you maintain a good budget, this is very possible.
That being said, lenders appreciate a borrower who is responsible for a good mix of credit lines. The remaining 10% of your credit score depends on it. If you’re about to cancel your only credit card or even one or two you may have, reconsider. Having an open line of credit, especially with low or no balance, can help your score. Plus, having one or two credit cards open adds to the blend of your credit mix.
Summary: The Do’s and Don’ts
DO close a credit card if it won’t affect your credit utilization ratio, or if it will but gets financially made up for in the process of closing the card.
DON’T close a credit card if it will increase your credit utilization ratio any more than slightly.
DO close a credit card if it has no balance and its available credit is minimal compared to your total available credit.
DON’T close a credit card if it has a balance. It will negatively affect your credit utilization ratio.
DO close a credit card if you have multiple others and all the previous criteria for not dropping credit score are met.
DON’T close a credit card if it’s your only one. You need to establish a good payment history as well as a good credit mix, so work on paying it down first.
DO close your very first credit card if it’s not being reported any longer to the credit bureaus.
DON’T close your very first credit card if it’s still being reported, (unless of course there are extenuating circumstances). It’s helping your score via the length of credit history.
We could probably each and all come up with a reason to cancel one of our credit cards. However, not enough of us will stop and think about how it may affect our credit scores. Well, now you’re fully equipped with the know-how. Pass the knowledge on and keep those credit scores on the rise!
Oh, and if after reading this you’ve determined that you’re A-OK to go ahead and cut the card, then congratulations and enjoy your walk to the scissors.
Chris Fuller went to the University of South Florida and has worked in the financial sector for over 20 years. He has extensive experience in all aspects of personal and small business lending, from personal loans, equipment finance to cash flow based solutions for small mom and pop businesses, and large corporations.