Is Closing a Credit Card a Good Idea?
If you’re doing your best to stay out of debt, closing credit cards may seem like a smart option to help rid you of the temptation of charging. However, closing your credit card can actually have a negative impact on your credit score. Consider the effects on your overall financial situation before cutting the cord on your card.
How Closing a Credit Card affects your Credit Utilization
Your credit utilization rate is the ratio of your credit card debt to the total limit on all of your credit cards. For example, if you have $300 debt and your total credit card limit is $1,000, then your credit utilization is 30%. Closing a credit card can impact your credit utilization because you will be decreasing your amount of available credit. Keeping your credit utilization below 30% is generally considered best practice. By reducing your available credit, you could push your utilization over that rate, even if you haven’t increased your use.
Your credit utilization rate is responsible for about 30% of your FICO credit score, so any drastic changes may cause a sudden drop in your credit score. A low credit utilization shows lenders that although you are using credit, you are not dependent on it. This is therefore a testament to your creditworthiness.
How Closing a Credit Card affects the Length of your Credit History
It is beneficial to show a longstanding and positive credit history because it can help boost your credit score. Closing a credit card may result in a lower average age of accounts. This will be especially prominent if you are looking to close one of your older credit cards. The average age of accounts does play a role in determining your credit score. It is important for lenders to know how long you have been handling credit. A long, positive history shows lenders that you have sound financial habits that you’ve sustained over time.
Credit history makes up 15% of your FICO credit score. Therefore, the older the age of your account, the better it is for your credit score, because it considers the average age of all of your accounts. If you choose to close an older credit card, the average age of all accounts will be lowered. Therefore, your credit history may be negatively impacted.
Steps to Take Instead of Closing a Credit Card
Because closing a credit card can negatively impact your credit score, consider other options before making the decision. Closing the card may seem like a good idea if you’ve paid the balance and don’t want to be tempted to use it anymore. Consider stashing it away instead. Out of sight, out of mind, right? However, you may want to make a small transaction on it every once in a while to avoid the creditor closing it due to inactivity. Just be sure to pay the purchase off right away.
Not wanting to pay an annual fee is another common reason for closing a credit card. Consider downgrading to a lower-level card with the same creditor instead. However, be aware that doing so may decrease your credit limit. This will also impact your utilization – though not as much as closing the card all together.
Closing your credit card could seem like a wise financial move for a number of reasons. However, many borrowers don’t realize that doing so can have a negative impact on your credit score. It’s important to note, also, that depending on other factors – such as how many other cards you have, how much debt you owe, etc. – your credit score will be affected to varying degrees. By understanding the effects of closing a credit card, you can make an informed decision about what is best for you and your financial situation.
If you have questions about managing your credit, contact the credit card debt professionals at Tayne Law Group.