Learn more about how closing credit cards impact credit scores.
A credit card, like most things, is okay to use in moderation. It’s when you abuse them that they become detrimental to your financial health. Some credit card advice is obvious, like paying off your balance before the end of the month and not maxing out all of your credit cards. On the other hand, the rules around closing credit cards are a little more complicated.
What happens when you close a credit card?
You might be considering closing a credit card account because you no longer use that card or the annual fee is too expensive. There are many reasons why people cancel credit cards, including wanting to avoid overspending. However, closing a credit card reduces your overall available credit, which can cause your credit score to drop if you have any outstanding debt. It’s important to weigh the pros and cons of closing credit cards before you cancel and prepare for the impact to your credit score.
How do credit cards impact credit utilization?
When you open a new credit card, you are approved for a specific credit limit – how much you can spend before making a payment. That new credit limit is combined with the credit limit of your other credit cards to calculate your credit utilization ratio, a major factor in your credit score.
Let’s say you open a new credit card with credit limit of $10,000. You have two other credit cards with a total credit limit of $20,000. Your total credit limit is now $30,000. As you increase your total credit limit, you can spend more and maintain a lower credit utilization ratio. The lower your credit limit, the more of an impact your spending has. For example, if you have a credit limit of $10,000 and you have $5,000 of credit card debt, your credit utilization is 50%. However, if your total available credit is $20,000 and you have $5,000 of debt, your credit utilization is only 25%.
Typically, the lower your credit utilization, the better your credit score. If you reduce your available credit by cancelling a credit card, and you have outstanding debt, your credit utilization will go up and your credit score will go down. You can counter the impact of cancelling a credit card by paying down debt before doing so.
What if I have a high annual fee?
If you have a high annual fee on a credit card you don’t use, or the annual fee outweighs the benefits you get from the card, it’s probably worth cancelling the credit card and taking the temporary hit to your credit score. Annual fees are typically charged on rewards credit cards, but they only make sense if you are benefiting from the rewards. Annual fees range from card to card, with more prestigious cards having fees just under $700.
What steps should I take before cancelling a credit card?
Don’t cancel a credit card right away if you are about to apply for a major loan, lease a car, or make a purchase that requires the lender to run your credit score. When you cancel a credit card, you will most likely see some sort of drop in your credit score, and you will want your score to be as high as possible when applying for funding to secure a competitive rate.
Before cancelling your credit card, try to pay down outstanding debt to bring your overall credit utilization down. This will soften the impact to your credit score.
If you want to keep your credit card, but the annual fee is too high, you might be able to negotiate with your credit card company. They could waive the annual fee or transfer you to the $0 annual fee version of the card. Note that credit card companies will typically only waive the annual fee for one year.
Cancelling a credit card will cause a temporary decline in your credit score. There are situations where cancelling a credit card makes sense, including if your debt is becoming unmanageable or your annual fee is too high. Attempt to pay down your debt before cancelling your credit card to soften the impact to your credit score.
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