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How Does Closing a Credit Card Affect Your Credit?
By Talon Abernathy MONEY RESEARCH COLLECTIVE
Does closing a credit card hurt your credit? Yes, depending on the circumstances. There are steps you can take to mitigate any damage to your credit. Additionally, sometimes closing a credit card might be the right thing to do even if it has a negative impact on your credit score.
In the following article, we’ll discuss the pros and cons of closing a credit card. Continue reading to learn how you can close your credit card while protecting yourself from a bad credit score.
Three ways closing a credit card affects your credit
How does closing a credit card affect your credit score?
1. Shortens your credit history
Credit scores help credit card issuers decide who to offer financial products like credit cards and personal lines of credit to. You can view your credit score on your credit report. You can access your credit report for free once annually for each of the major credit reporting agencies. Credit scores are calculated using details of your financial history.
Lenders like to see that you’re capable of responsibly maintaining credit over a long period of time. Closing a credit card, particularly an old one, will shorten your credit history. This can lower your credit score. But it’s worth noting that FICO, the most common formula used to determine credit scores, will keep your closed credit cards on file for up to 10 years after you close them out. This means that the impact of closing out an old account might not be felt for some time.
2. Increases your credit utilization rate
Your credit utilization rate is a key component of your credit score. Under the FICO formula, it can determine up to 30% of your total score. Credit utilization is measured as your statement balance divided by your credit limit multiplied by 100 and expressed as a percentage. For example, if your credit card debt is $1,000 and your credit limit is $10,000 then 1,000 divided by 10,000 equals 0.1. Multiply by 100 and you have a credit utilization rate of 10% which is considered healthy.
When calculating your credit utilization rate, you should take into account all of your credit cards to reach a total credit limit. For example, if you have two credit cards and each has a credit limit of $5,000 then you have a total credit limit of $10,000. If you have $3,000 in debt on card A and $2,000 in debt on card B then your total debt is $5,000 and your credit utilization rate is 50%.
If you close a credit card – even one with a zero balance – your total credit limit goes down. And that means that the total you owe on your other accounts comprises a higher percentage of your new credit limit. That, in turn, may depress your credit score.
For example, suppose you have three credit cards, each with a $7,000 credit limit. You owe $800, $600 on card two, and $0 on card three, for a total owed of $1,400. Your total credit limit is $21,000 and your total balance is $1,400. Your credit utilization is therefore 6.7% ($1,400 / $21,000 x 100). But now suppose you close the card with the zero balance. Now your outstanding debt remains the same but your total credit limit has been reduced to $14,000. Your new credit utilization rate is 10% ($1,400 / $14,000 x 100). That increase in your credit utilization rate may lower your credit score.
3. Reduces credit limits
As we saw in the last section, credit card closure reduces your credit limit. This means you won’t be able to borrow as much money. If you are a prolific spender and you’re trying to cut back, this may help reign in your spending. However, if you change your mind and decide you need more access to credit, opening up another credit card can negatively impact your credit score since most credit card companies use hard credit inquiries during the approval process.
How much will closing a credit card affect your credit score?
The two major credit scoring models, FICO and VantageScore, deal with closed credit card accounts in slightly different ways. What hurts your credit score with FICO may not hurt your credit score with VantageScore. That’s because FICO keeps records of your closed credit cards on file for seven to 10 years depending on whether it has a negative or positive impact on your credit score respectively. Meanwhile, VantageScore does not keep closed credit cards on file. Most (but not all) lenders prefer FICO to VantageScore.
Closing with a balance
Closing a credit card with a balance is possible. However, you’ll still have to pay off the outstanding balance and any past-due payments will accrue interest fees. It’s recommended that you pay off the balance in full before you proceed with the cancellation. Alternatively, you can transfer the balance to a new credit card. Refinancing your debt may make sense if you can find a new card that offers a lower APR. Some credit cards also provide incentives for debt consolidation.
Closing without an outstanding balance
Closing a credit card with a zero balance will negatively impact your credit utilization rate unless you’re carrying zero debt across all of your accounts. In advance of closing an account without an outstanding balance, pay down all of your debts first. As you begin to take on new debt, remain mindful of your lower total credit limit. Consider requesting a credit limit increase on your remaining card(s). This will help keep your utilization rate down.
Is it better to close a credit card or to have an unused credit card?
Generally speaking, it’s better to keep your unused credit cards open. Not only will your unused card lower your credit utilization rate, but maintaining long-standing credit accounts is good for your credit health. That’s because credit bureaus use your average account length as a major factor in your credit score. FICO weights credit history at 15% of your total score while VantageScore assigns credit history at 21% of your score total.
However, certain circumstances exist in which it makes more sense to close an unused credit card. These will be covered in more depth in the next section. A quick summary of the reasons you might choose to close a credit card includes:
- High annual card fees
- A decision to use alternative financing methods
- Poor spending behavior
It’s worth noting that your credit card company may close your account if you don’t use your credit card for a certain period of time. Avoid this by setting up a single, recurring monthly bill to charge the card. Then set up an automatic payment system to pay off your monthly balance.
When does card closure make sense?
While it’s generally a better idea to maintain old credit card accounts, credit experts suggest closing credit accounts under certain circumstances. Here are two of the most common reasons to close out a credit card account.
When you want to part ways with high annual fees
Some credit cards charge high annual fees just for having the card. Paying these fees may sometimes be worthwhile. For example, if your credit card offers travel reward points and you’re an avid traveler, the fees could quickly pay for themselves. Fees usually stop making sense when you don’t use your credit card as often or if you find the rewards less helpful. If you go from traveling multiple times a year to only traveling once a year, that annual fee may no longer make financial sense.
Before you cancel a card because of its high annual fee, call up your card provider and request that they waive the fee. You might be surprised by the result. Credit card companies will sometimes waive annual fees to retain your business. In other cases, they may help you get a new card without an annual fee that still meets your needs.
If you’re successful, they’ll simply take down your personal information and voila, you’re fee free to go. Bear in mind that getting your annual fee waived once doesn’t mean your credit card company will continue to waive your fee in perpetuity. Make sure to ask your service representative for the exact details. If they’re willing to extend a one-time courtesy waiver, you may still need to cancel your card next year.
You’ve settled on other responsible credit options
A personal line of credit functions similarly to a credit card. Both are revolving forms of credit that allow you to borrow up to a set amount of money before paying it off. Both charge interest on late payments. You may even receive a card that will let you access your personal line of credit. Other banks and lending institutions will issue checks. Some may provide both options.
The main difference between the two lies in accessibility and credit limits and fees. Personal lines of credit tend to be more difficult to get than credit cards. This is because they often charge lower APR rates and offer higher credit limits compared to most credit cards.
Other forms of consumer loans, such as buy now pay later may make more sense for you, for a few different reasons. You may secure better terms on individual installment loans that ask you to pay back an upfront lump sum payment in a series of smaller, scheduled payments. If you worry about your spending habits, taking out individual installment loans may protect against impulsive purchases.
Credit card cancellation could make sense for you
You may want to consider closing a credit card with a negative balance and transferring the balance to a new card with lower fees, in a process called credit card consolidation. Credit card consolidation can lower future charges if the new credit card has a lower APR than the old card. Some types of credit cards even offer incentives to consolidate your debts. For example, they might offer 0% APR for a set period of time after you refinance.
If you have a habit of making minimum payments on your credit card bills, you should probably close your card. Interest fees will almost always be more expensive than whatever money you can save by holding on to an old account. Plus, closing your account may give you the motivation you need to pay off your balance and work toward a good credit score.
Similarly, if you don’t have a good relationship with your credit card, it might be time to close out your account. Some people struggle to use credit cards responsibly because the spending is less tangible. If you don’t look at your balance statement often, it’s easy to lose track of how much you’re spending.
One study by MIT’s Sloan School of Management found that consumers were willing to spend more money and spend more often when they had access to a credit card compared to making cash purchases. Even if you don’t have a spending problem, your budget may benefit from subbing out your credit card for cash.
If you do decide to close a current card, you may need to fill out a credit card closure form. While not strictly necessary, sending a credit card closure letter can serve as proof that you’ve requested to close your credit card account on a certain date. You should do this if you’re afraid your lender is unscrupulous or if you’re worried about the competency of their staff.
While you’re thinking about your credit score, order an annual credit report and check to see if you’re one of the 34% of Americans who have an error on their credit score. If you find false or out-of-date information, you can fix it yourself by calling up the responsible credit reporting firm. However, if you’d like to receive assistance from a professional service provider, consider contacting a reputable credit repair company.
Talon Abernathy is a freelance writer, former teacher, and author. He has written on a broad variety of topics including SaaS for business, the legal industry, and personal finance and investing. He excels in simplifying complex topics while writing with an eye toward SEO and reader satisfaction.