Thinking about Cancelling All Those Credit Cards? Think Again

Thinking about Cancelling All Those Credit Cards? Think Again

"Spend $500 in the first three months and get $100 back." Remember, the last time you signed up for a credit card like that? Or being tempted to do so, only to think, I can always cancel the card later. Well, think again before signing up for cards just for promotional rewards and then canceling them. Truth is, canceling your credit card can be damaging to your credit score.

First, let’s start off with what makes up our credit score:

Accounting for 35% of our credit score is our payment history. Yes, this means please pay your bills on time.

Trailing closely behind, the number of accounts you have and the amount you owe on them accounts for 30% of your score.

Coming in third is the length of your credit history, which makes up for 15% of your score. Hence, think twice before closing a credit card that you’ve had and used for a long time.

Fourth is the number of recently opened accounts and latest credit inquiries, making up 10% of your score.

Last but not least is the number and types of accounts you have, such as credit cards, mortgages, auto loans and etcetera. Having a nice mixture of various types of accounts can be a good thing for the last 10% of your credit score.

Now that we know the factors that come into play when determining your credit score, can you see how canceling a credit card can negatively affect most of the factors mentioned? For example, for FICO, a renowned credit score company, the credit utilization ratio comes into play when we look at the second credit factor mentioned. Credit utilization is the number of credit accounts you have and how much you owe on them. It is expressed as a ratio of your credit balances to your credit limits, also known as the debt to credit ratio.

For example, if you have a credit card with $1000 limit and your balance on the card is $250, dividing your balance by the limit will give you a credit utilization of 25%. The general idea is the lower your credit utilization ratio, the better. Many credit experts propose keeping it below 30%.

So, here’s how canceling a credit card can affect your credit utilization ratio and ultimately your credit score. Canceling a credit card on hand will reduce your available credit limit. As the number in the denominator of the credit utilization ratio decreases, the ratio itself increases and negatively affects your credit score.

But what if you have good reasons to cancel a card. Maybe the interest rate is too high or the annual fee is outrageous. No worries. Canceling a card does not have to be damaging to your credit. Here’s how:

Pay off all your balances before canceling a credit card. If the balances on all your accounts are zero, your credit utilization ratio will be zero no matter what your credit limit is. Hence, in this case, although your credit limit went down, your score can remain as it is.

Before canceling a card, you can request a credit limit increase from another one of your card company. If you’ve been a good card user and have a good history with the company, the request should be easily granted. This increase in credit limit may offset the credit limit associated with canceling your card.

Nonetheless, although canceling a credit card may damage your credit score, it is still important to remain a responsible cardholder. This means paying all your bills on time, not maxing out your cards, and open new accounts only when necessary.

Find the best credit card for your needs.

Image: Image courtesy of James Barker at FreeDigitalPhotos.net

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