You’ve probably heard that closing a credit card is a bad idea because it can hurt your credit score. But there’s more to the story than just a few numbers. Discover what happens when you close a credit card to see if it’s a good idea for you.
What Happens When You Close a Credit Card?
Closing a credit card doesn’t mean cutting your plastic card in two and not using it anymore. When you close a credit card, you’re giving up a line of credit and closing the account altogether. It can take several weeks for the account to show up as closed. When it does, you’ll see it listed as closed with a zero balance in your credit report; unless you have a balance left on the card, in which case, you’ll see the account with a balance due.
Depending on several factors, your credit report may look very different as a result of the closure. You might find that your:
- Credit age has changed
- Credit utilization ratio has gone up
- Credit score has decreased
How Credit Age Can Change When You Close a Credit Card
Your credit age can change based on the date you opened the credit card. For example, say you have three credit cards. (For simplicity of this example, assume that you don’t have other credit items in your report.) You opened one credit card while you were in college 10 years ago; the second one three years ago; and the third one last year. You choose to close the oldest one because it has an annual fee and the other two don’t. It’s a good choice to get rid of that annual fee, but now the age of your credit is no longer 10 years but three years. This could be seen by lenders as a negative mark.
How Credit Utilization Can Change When You Close a Credit Card
One factor in your credit report is a balance-to-limit ratio, which is also known as your credit utilization ratio. This is exactly what it sounds like – the ratio of your total credit balance to your total credit limit. Most lenders want to see a credit utilization of 30% or less. When you close a card, you lose the credit limit from that account.
So, from the previous example, if your three credit cards had limits of $1,500, $1,000 and $750, respectively, your total credit limit was $3,250. If you had a zero balance on the $1,500 card, a balance of $500 on the $1,000 card and $200 on the $750 card, you would have been under the 30% threshold because you were only using $700 of the $3,250 credit limit. But after you close the $1,500 card, your credit limit goes down to $1,750 so your credit utilization goes up to 40%, which is higher than the ideal and can affect your credit score.
How Closing a Credit Card Affects Your Credit Score
Many factors go into determining your credit score. That’s why closing a credit card might make one person’s credit score drop significantly while another person’s might only change by a few points or not at all. Here’s a breakdown of the weight each factor has on your credit score:
- Payment history – 35%
- Amount owed – 30%
- Credit age – 15%
- New credit – 10%
- Type of credit used – 10%
As you’ve seen in the previous examples, your credit age and credit utilization can change drastically when you close a credit card. These both affect your credit score.
If the account you close is one you had a good payment history with, you might be reducing your score even more by closing it. Another factor that could hurt your credit score is if you are closing the only credit card you have because that will reduce the types of credit you use. Also, if you have multiple cards but the one you close is the only one with available credit (which could happen if you’ve transferred the balance to a lower interest card or paid the card off), that could also negatively affect your credit score by decreasing your available credit.
When Is It Okay to Close a Credit Card?
After reading all of this you might think that you should keep your credit cards open forever. But there are a couple of times when it’s better to close a card than keep it:
- If you are having a difficult time controlling your spending, it might be better to remove the temptation. This doesn’t mean you can’t have the occasional splurge on a pair of shoes, but if you have serious spending problems and can’t stop, it’s probably a good idea to pay off the card and close it.
- If the terms of the card are no longer friendly or efficient, such as high annual fees or interest rates, you might be better off finding a different card.
Whether you choose to keep your credit cards or close one, it’s always a good idea to check your credit report first to see where you stand. For more tips on how to manage your credit and debt, be sure to check out the Finances section of the Zing blog for help you can depend on.
Source: Home Loans