How Closing a Credit Card Impacts Your Credit Score
I’m a big believer in using different credit cards for different purposes. I have a business card so I can keep my personal and work expenses separate. I have a card that helps me earn points on my favorite airline. And I have a card for everyday expenses.
In the past, I’ve used certain cards because they provided a great sign-up bonus or helped me save money on everyday spending. Credit cards are useful financial tools that can help you leverage your cash flow and make the most of every dollar you planned to spend.
But there’s a downside: eventually, you end up with a lot of credit cards. I know I did. I had six to eight cards at one point, and that was way more than I needed.
It was also a lot to keep up with and track. Even though I didn’t use more than one or two cards at a time, I still needed to keep tabs on every open account. That’s part of being a responsible cardholder. You need to review all information periodically to guard against fraud and to make sure there are no mistakes on your accounts.
What to Do When You Have Too Many Cards
When I ended up with too many cards, I knew I needed to close one (or more) to keep my financial life organized. But I wasn’t sure what to do about that.
After all, I heard the oft-touted advice never to cancel a credit card -- even if you don’t use it. Most “financial gurus” will tell you to just put it in a drawer somewhere and forget about it. Some will even tell you to destroy the card and leave the account open.
There are a couple of problems with this: for one, putting away (or destroying) the card to an active account and simply forgetting about it may cause the credit card issuer itself to cancel the account eventually. If enough time passes without activity on the account, the company will usually cancel the card.
The other problem? While your credit score can drop if you cancel a credit card, this isn’t a hard and fast rule. It also doesn’t mean there are never any reasons to close an account -- and it doesn’t take into consideration the fact that a drop in your score may be too insignificant to even worry about, let alone stop you from doing what’s best for your finances.
If you’re worried about closing credit accounts, it’s time to take a deeper dive into the issue. Know why it matters, what can impact your score, and whether or not you should cancel your credit card.
How Closing an Account Affects Your Credit Score
This makes much more sense when you understand FICO credit scores and how credit reporting agencies calculate that number. Your FICO score is just one type of credit score -- there are others out there -- but this is the one that matters.
90% of lenders look at and use the FICO credit score to determine if they’ll approve you for a new account or line of credit. This was the original score, and it’s still the most important one to know today.
What we don’t know is exactly what formula FICO (which stands for Fair Isaac Corporation) uses to get an exact credit score for individuals. But you can look at the five factors that determine your score and how they’re weighted to get an idea of what actions influence the actual formula.
FICO Credit Score Factors and Their Percentages
|FICO credit score factors||Percentage weight on credit score:||What it means:|
|Payment history||35%||Your track record when it comes to making (at least) the minimum payment by the due date.|
|Amounts owed||30%||How much of your borrowing potential is actually being used. Determined by dividing total debt by total credit limits.|
|Length of credit history||15%||The average age of your active credit lines. Longer histories tend to show responsibility with credit.|
|Credit mix||10%||The different types of active credit lines that you handle (e.g., mortgage, credit cards, students loans, etc.)|
|New credit||10%||The new lines of credit that you've requested. New credit applications tend to hurt you score temporarily.|
This is why whether you close an account or not matters, and makes an impact. When you cancel a credit card, it affects your credit utilization ratio and the average age of your accounts. The result when you cancel a credit card could be a lower score.
So the question is, how exactly does this happen -- and if canceling a credit card lowers your score, how much does it drop?
The Impact on Debt Utilization When You Cancel a Credit Card
A large part of your credit score is made up of how much of your available credit you use. This is known as your credit utilization (or debt utilization) ratio, and it’s best to keep this as low as possible. The higher the ratio, the more your credit score is likely to suffer and drop.
You can calculate this ratio by taking the amount of total credit you use and dividing it by your overall credit limit. So let’s say you have three credit cards, each with a $1,000 limit. Your total credit limit is $3,000.
Now, suppose you charge $200 to the first card, $100 to the second, and $500 to the third. The total amount of your credit that you use when you do this is $800. So your credit utilization ratio is just over 26%.
But you want to cancel a credit card. So you close that first card and are left with the second and third cards that you still use. When you close that credit card account, the credit line disappears.
If you still charged $100 to the second card and $500 to the third, you used $600 of your available credit -- but because you closed that first card, your available credit limit changed and is now $2,000.
That means your credit utilization ratio is 30%, higher than it was when you kept three cards in your wallet. If you cancel a credit card and your credit utilization ratio increases; as a result your credit score could drop.
How Closing Accounts Impacts Your Overall Credit History Age
Closing an account can also lower your score because it influences another important factor in determining your credit score. That’s the average account age metric that the formula considers.
This doesn’t make as big of an impact on your score as the credit utilization ratio, which forms a full 30% of your credit score. And to be clear, when you cancel a credit card, it does not remove the account’s age from the overall calculation.
What does happen is the account’s age stops increasing. Which, of course, makes sense -- you no longer keep the account active if you close or cancel it.
Because it’s not increasing, it influences the overall average. It could drag that average down. That correlates to a lower credit score.
This is why the advice to “not cancel a credit card” is usually a little more specific. Experts often say not to cancel your oldest credit card account. If possible, follow that advice.
Keeping your very oldest account open and active means newer accounts that you open and eventually decide to close have less of an impact on the average age of your credit history. That’s thanks to the oldest account that grows in age over time.
Should You Close Your Credit Card Account?
Closing your credit card account can impact your credit score. It may cause it to drop by a lot or a little -- or you may not notice a change at all. It’s best to expect your score to drop so that you’re prepared.
That being said, should you close your account at all? In many cases, it makes sense. If it costs you money in terms of annual fees, close the account.
You should also go ahead and close the account if it will improve your financial life in other ways. That could happen by removing the temptation to spend more than you can afford, or simply by helping you get organized if you can pare down to just a few essential cards.
If your score does drop, it’s only temporary. You can take action to help it recover.
The best thing to do is continue making full payments by their due dates on all other accounts, and paying down any balances you have. You should also watch how much you charge to your remaining cards since your available credit will be lower than in the past.
If You Do Decide to Close An Account
You can also manage your score by only closing a single account at a time. When you have multiple cards you want to cancel, close one at a time over a period of time. Try to leave at least six months between each closed account, so your score won’t get hit by multiple cancellations all at once.
In general, it’s perfectly okay to cancel a credit card if you’re ready to do so. There is, however, one big exception.
Don’t close any credit accounts if you’re planning on applying for a new loan, like a mortgage, or another important line of credit. Too much activity in your file -- whether it’s opening new accounts, having a hard inquiry hit your credit, or canceling cards -- can drop your score significantly.
That’s the last thing you want right before applying for a loan you need. At best, it will impact the interest rates available to you. With a lower score, you won’t get the lowest rates on the market.
At worst, it could prevent you from getting approved for the loan at all. So if you’re about to apply for a loan or big line of credit, avoid making any changes -- from opening to closing accounts -- until after you finish that process.