Managing credit cards is a huge part of your financial wellness, so optimizing the amount of credit cards and your access to credit is very important in establishing a good credit history in case you need a loan.
What should you do with all your credit cards that sit dormant and have a zero balance? If you have ever wondered this, then you should be really careful before you cancel a card. While it is usually better to just leave the account open at zero balance, if the bank starts charging fees or if those cards at zero balance extend your available credit to too high a number, you may want to consider closing the account. However, be extremely prudent when you close a credit card because it can have adverse effects on your credit score.
If you carry a balance, then closing an account will effect your credit utilization (also known as a balance-to-limit ratio), which compares your card balances to the limits on those cards. According to most experts you want to keep this ratio below 35% because it means you have little debt and lots of available credit. Imagine that you owe $3,000 in debt across several cards with a combined total of $10,000 in available credit lines. This means that your credit utilization is 30% which is healthy. Then you decide to close a card, which has a zero balance, but a $5,000 line of credit. Now you have half of your original available credit and as a result, your existing $3,000 in debt boosts your credit utilization up to 60% hurting your credit score in the process.
You should also consider that too much available credit can also negatively effect your credit score although probably not as dramatically. Imagine that you owe $1,000 in debt across cards with $100,000 of available credit. Lenders may be wary to loan you money because you can technically go to town tomorrow and spend the other $99,000. Therefore, having excessive access to credit is also not ideal.
Essentially, you want to have an amount of credit available to you that is comparable to the amount of income that you have, in order to assuage lenders so they know you are reliable in paying back and judicious in your spending. Lenders will take into consideration if there is a risk you might overspend on either end of the spectrum.
Closing the Card
Of course, if you don’t carry a balance at all, then the utilization ratio remains zero no matter how much available credit you have, and you are in the clear. But there are other factors to consider.
You do not want to close a credit card that you have had for a long time. The most weighted category in your FICO score is your payment history, so if you have paid off a card every month on time for years, the long and positive history will benefit your credit scores. Closing an older account could potentially have a very negative impact.
Assuming you’ve evaluated your credit utilization and you are not closing an old card and you have a good enough reason to close the account (fees, avoiding excessive spending, protection from fraud) then you can finally go ahead and close it.
Although it may be worth temporarily holding off on closing a credit card while in the market for a loan or mortgage, canceling a credit card shouldn’t be a source of major concern for consumers with good credit, since the resulting impacts on their credit scores are likely to be mild and temporary.