When to Close a Credit Card So You Don't Ruin Your Credit
Are you considering closing out a credit card? Maybe the terms of the card -- the annual fees, the interest rate, or both -- are no longer what you signed up for. Or, maybe you hope it will help you avoid excessive spending. But then you've also heard that canceling a credit card may impact your credit history in a bad way.
While you always have the option of contacting the card provider to request a lower interest rate, there is no guarantee you'll get a favorable response. Same drill with cards that charge annual fees, and if you have a number of these cards, those fees can add up. When a provider proves unwilling to bend on interest, waive its fees, or cut you some kind of customer retention deal -- you've found a good target for cancellation.
Credit experts tell us it makes sense to cancel a card that's unnecessarily costing you money. The key is to know when to close a credit card and how to do it to your best advantage.
When to be Worried about your Credit
Closed accounts with zero balances and no associated negative information typically remain on a credit history for 10 years from the date they are reported closed. Positive information remains longer than most negative information because bad marks on your credit report have an expiration date. Negative data such as late payments and foreclosures need to come off the credit report after seven years, by federal law. Experian, for example, provides an online list of how it deletes information from its credit reports.
When you close a credit card, you effectively close any available credit limit associated with that card. If the card has a large available limit, closing it would eliminate any future use of that available credit limit and could potentially have a negative impact on your credit scores. The issue involved is called “Revolving Utilization.”
Revolving utilization is the percentage of your balances in relation to your credit limits on your credit card accounts and is said to influence your credit scores. The FICO score specifically, looks at both the individual utilization on each credit card, and the aggregate -- or total utilization -- across all of your credit cards.
To calculate your revolving utilization percentage, all you need to do is add up all of your credit limits on each of your credit card accounts and then do the same for all of the balances on each card. To get your revolving utilization, divide your total balances by the total credit limits:
Total Balances ÷ Total Credit Limits = Revolving Utilization PercentageWhen deciding whether or not to close a credit card it’s a good idea to run this calculation on your own, so you can see how closing the card will impact your revolving utilization. As long as closing the account won’t cause your revolving utilization percentage to spike, the impact to credit scores should be minimal.
All things being equal, you may want keep the credit card open and simply not use it. This would allow you to keep the open credit limit and would help your revolving utilization ratio. As far as your credit scores go, the lower your utilization, the higher your score will be.
When to Close
Often we get suckered into promotional deals for miles, points or gifts. For example, Sally signed up for one and now can't use her promotional miles. She lived in Washington, D.C., and traveled fairly often for business, so her US Airways credit card was a great way to earn extra miles. But once she moved to Florida and found herself flying Delta or Southwest almost exclusively, it no longer made as much sense.
Like most airline reward cards, hers carried hefty annual fees after the first year. She'd likely want to close these accounts and switch to cards with a more useful rewards program. If her credit is good, any damage to her credit score should be minimal and disappear within a few months.
Another example is Bryan, who used to have several credit cards with annual fees, a car note, a personal loan, and department store cards. But, once he hit a certain income level and decided to act more responsibly with his money, he paid them all off one by one.
After paying off his cards, he closed the ones that had annual fees. Bryan decided to keep one card open in case of an emergency -- it was the credit card that had no annual fee and a low APR.
Is There a General Rule?
There is no definitive and clear "general rule" about what to do with your credit cards vis-a-vis your credit score. Since the exact formula for credit scores isn’t known, we have to guess when it comes to what to do to maximize our credit scores while, at the same time, balancing our other risks.
If your primary goal is to raise your credit score by a few points, you’re probably better off leaving your cards alone, unless there's a pressing need to close them. It maintains your debt-to-credit ratio. However, if you’re a compulsive spender, or perhaps you’re looking at getting a home loan soon, you should get rid of extra cards.
Bottom line, the best thing you can do is to only have a few cards to begin with and, most importantly, don’t put a lot of money on the cards. That way, your credit-to-debt ratio is good and you don’t have a lot of sources of revolving credit and you don’t have a lot of credit numbers sitting out there, either. Because of that, when people begin paying off their cards and getting into good financial shape, it makes sense to gradually cancel unused credit cards.
If you know when to close a credit card and decide to do so, check your credit report after a couple of months to make sure the account is marked "closed." You can pull a free copy of your credit report once a year from each of the top three credit bureaus (Equifax, Experian and TransUnion) at AnnualCreditReport.com.