Is it bad to close a credit card? | Credit card
When it comes to credit, there are few absolutes. If you miss a payment, it’s never good. On the other hand, the cancellation of a credit card is usually a bad idea, but there are a few exceptions.
Before you close a credit card, you need to consider two things: the overall economy and your current credit status. The inflation rate for the 12 months ending March 2022 was 8.5%. Unless you have a stable job situation and an emergency fund, I recommend keeping your credit cards on hand in case you need them.
Another thing you need to consider before closing a card is the health of your credit history. It is important to know your credit status so that you can determine the possible impact on your credit score.
How to find your credit score
You can find your credit score in a number of places these days. Check your monthly credit card statements as many issuers offer free scores. With many issuers, you can also simply log into your account and see an option to request a credit score. There are also free sheet music on many websites and apps. These scores won’t always be a FICO score, but you’ll still get an idea of your credit status.
If you really want a snapshot of your FICO score and your card issuer doesn’t offer it, you can purchase a FICO score from myFICO.com. The site offers a credit bureau report and your FICO score. Be careful, however, not to accidentally sign up for a monthly monitoring service.
If you have excellent credit, you are well placed. That’s not to say it’s okay to close an account, but it does put you in a good starting position.
How does closing a credit card affect your credit score?
Five factors make up your FICO score: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and credit mix (10%). Credit score algorithms use information from your credit report to calculate your three-digit score.
When you cancel a credit card, several factors may be affected. This, in turn, affects your credit score.
Canceling a credit card can increase your credit utilization rate
One of the most important factors – 30% – that is weighted by the FICO score is your credit utilization rate. This is the amount of credit you have used compared to the amount of credit you have. A ratio below 30% is acceptable, but closer to 10% helps boost your score.
So, let’s say you have four credit cards and they each have a credit limit of $15,000 (and yes, I’m simplifying the math on purpose). That’s $60,000 of available credit.
You have a balance of $2,000 on three of the cards and a balance of $1,000 on the card you want to close. Your ratio is 11.7% (7,000/60,000), which is almost fantastic. You then pay off the $1,000 balance on the card you wish to cancel. After closing the account, your ratio is now 13.3% (6,000/45,000).
In this scenario, you might lose a point or two. But if that card has an annual fee and you’re not using it, you might decide it’s worth it. Your score will bounce over time.
But what if you determine that your ratio would exceed 30% if you close the credit card in question? This is an other story. Your score might drop a bit, depending on the details of your financial situation.
How closing a credit card affects your credit history
You might think it’s not important since your history is only 15% of your score. But every point counts, so if you want a high credit score, you need to pay attention to the five factors.
Now, how long have you had credit? If you only have a few years under your belt, closing an account is not a great idea because you may only have a few lines of credit on your report.
The good news is that your history won’t be immediately deleted from your credit report. In fact, it could stay on your report for up to 10 years, so you won’t see a negative impact on your average credit history right away. But you probably don’t want to close any of your few accounts at this point.
When you apply for credit, the lender reviews both your score and your credit report. You seem less risky when you have multiple accounts showing you paid as agreed.
How closing an account could impact your credit mix
Like credit history, this factor doesn’t get much attention because it only accounts for 10% of your FICO score. This is another situation where being relatively new to credit could be a disadvantage.
Let’s say you have a student loan (installment account), a car loan (installment account), and a credit card (revolving account). If you close your credit card, you have two installment loans left on your credit report. Without the credit card account, you have no credit mix. It won’t be a big drop for your score, but if you’re on the bubble between fair and good credit, a few points really matter.
Next, I’ll show you how to tell if you’re on the bubble and what to do if you are.
Is your credit status on the bubble?
For some consumers, it’s possible that a few points below your score could drop you into a lower credit range. Let’s look at someone who has a FICO score of 670, which barely makes them in the good credit bracket. This person has these three credit cards:
- Card A: $5,000 credit limit with a balance of $3,000.
- Card B: $4,000 credit limit with a balance of $2,000.
- Card C: $3,000 credit limit with zero balance.
The credit utilization rate for this consumer is 41.7% (5,000/12,000), which is already too high. But now, the individual closes card C. The new ratio? That’s 55.6% (5,000/9,000), which will likely lower that consumer’s credit score.
Here’s the thing: Closing the C card could drop that score into the fair credit range, which is in subprime territory. Once you’re in that range, if you need credit, your interest rates will be high. So make sure you have a credit rating strong enough to withstand a downgrade.
One last thing: if you’re rebuilding a bad credit history, I don’t recommend closing credit cards. You don’t want to stop the momentum if you see your score improving. Hang in there if you can and keep working on your score. You can ditch the card later when you’re in excellent credit shape.
How to Cancel a Credit Card Account with Minimal Damage
OK, now you are empowered with the credit facts. You don’t want to close an account if it drives up your credit utilization rate, especially over 30%. And you don’t want to spoil the progress if you’re rebuilding your credit.
If you decide that canceling a credit card is the right thing to do and you need a replacement card, consider opening a new credit card account before canceling the old one. This way you replace some (or possibly all) of the available credit that is factored into your credit utilization rate.
But I don’t recommend opening a credit card account if you don’t need it. This strategy works best for someone who needs a certain type of card. For example, you have an airline mileage card, but you realize that you don’t travel enough to justify the annual fee. In your current situation, you might believe you can get more value with a cash back card.
If you don’t need another credit card, ask your credit card company if you can increase the credit limit on one of your other credit cards. This will help minimize the increase in your credit utilization rate.
But, of course, ask for the increase in the limit before you cancel one of your other credit card accounts.
Closing a credit card isn’t your only option
If you decide that canceling a credit card is a risky decision for you, you can always take steps to improve the situation:
- Request an upgrade from your current transmitter. This is a viable option if you’re looking for a rewards card and your issuer has one that fits the bill.
- Downgrade your current card. If you’re trying to avoid an annual fee and your issuer has a card with less – or zero – rewards, this allows you to keep a version of your card, keep the account open, and also save money.
- Keep the credit card for now. It’s a good choice if you decide your credit can’t handle the possible drop in your score. Use the card once a month to keep it active.
- Hide your credit card. Avoid overspending by putting your card in a drawer or in the freezer. I once heard a reader say she took that idea and took it up a notch. She put it in a jar of peanut butter and put it in the freezer. If you’re prone to impulse buying, this is a great way to give yourself a cooling off period (pun intended) to allow the urge to spend to pass.