In my earlier years, I made an effort to improve my credit score by closing unused credit card accounts. I never had a balance because I was afraid that if I had too many credit cards, I wouldn’t be able to get any more. It wasn’t until years later that I realized how simplistic that assumption had been and how nuanced the actual situation actually was.
Understanding the methodology behind one’s credit score might shed light on the potential negative effects of canceling a credit card account. Companies used to look at your credit report to figure out if they should extend you a line of credit or not. The credit bureaus of today reduce your credit history to a single figure called your credit score.
How Your Credit Score Is Made Up
It takes several things, including:
- 35% of your credit score is based on how reliably you’ve paid bills in the past.
- Your credit score is based in large part on your total amount of outstanding debt (30%).
- 15% of your credit score is determined by the length of your credit history.
- Twenty percent of the total is split evenly between new credit and the various forms of credit accounts you already have.
Your credit score is Affected by Closing a Credit Card
The average age of your accounts drops when you close a credit card, which might have a negative impact on your score. For the same reason that taking on new debt can lower your credit score, so will closing an existing credit card account.
When you close an account, it lowers your credit utilization ratio. The use of available credit is measured by the credit usage ratio. If your credit card has a $5,000 limit and you’ve spent $2,500 of that, you’re using 50% of your available credit. Higher ratios have a negative effect on credit scores.
When to Close an Account and How
Having a large number of accounts open is viewed favorably by credit bureaus, so there’s no need to close useless ones. Many financial experts advise maintaining a minimum of four active credit card accounts.
Follow these steps to shut your accounts if you need to cancel any of your cards:
1. Simply close new accounts.
Don’t cancel your oldest credit card just because you need to close an account. Ideally, the account with the longest payment and usage history would be allowed to continue operating. Make it a priority to close deals with new clients.
2. Cancel annual fee-based credit cards
Avoid carrying around unused credit cards with annual fees, but don’t cancel your cards before the costs are due. Put in a call to your credit card company and ask them to cancel your late penalties.
Cards with identical features but no annual cost can be requested as an alternative. Make sure the credit card provider doesn’t shut your account and re-establish a new one, though, or that would defeat the point of keeping the old account open in the first place.
3. Terminate Accounts That Aren’t Performing
While keeping your hand to four to six cards is recommended, you may have to part with some of those you value less in order to gain the card you really want. When you’ve gathered the necessary cards, put away the extras by closing one or two of the decks.
4. If You Need to Close Several Accounts, Do It Slowly
Don’t go and shut off every account you no longer use all at once. Your credit utilization ratio and score will suffer as a result of your decision. It’s best to close your credit cards one by one, and over as long a period of time as you can if you need to make changes.
Opening too many accounts at once might have a detrimental effect on your credit score, so spread out your account openings.
5. Don’t close accounts prior to the loan application.
Keep your accounts open if you expect to submit an application for a large loan during the next few months. Even if the accounts’ closure won’t have much of an effect on your credit score, it’s still a good idea to close them before applying for a major loan.
6. Be Certain to Close the Account
In the event that you are having financial difficulties with any of your accounts, you should make every effort to settle the balance or transfer the funds before the bank cancels the account. Your credit score will take a hit if your bank closes an account.
7. Pay attention to rewards
Many credit cards that offer cash back or travel rewards have rules that state that if you shut your account you will not be able to keep any benefits you’ve earned. Using the Costco True Earnings American Express Card (a Money Crashers partner) as an example, consumers only receive cash back once each year.
Your reward check will be voided if you cancel the card before it arrives. Unless you plan on canceling your account entirely, you should cash in any rewards you have earned before closing your rewards card.
8. Don’t Share Your Life Story With Them
When you call your credit card company to cancel your account, a representative will want to know why. You don’t have to answer this question unless you want them to give you something in exchange.
Explain that you are closing the account for personal reasons and that you are unable to provide any further explanation at this time.
Bottom Line
Don’t close credit cards unless you absolutely have to; doing so can have a negative effect on your credit score. But if you can’t keep paying down a line of credit, then close the account.
After all, making on-time payments and lowering or eliminating debt is far more beneficial to your credit score than canceling a line of credit. Closing an account won’t have much of an effect on your credit score if you’ve been responsible with your credit cards and rewards.
