Editorial Policy

Think Twice Before Closing a Credit Card

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By Eva Norlyk Smith, Ph.D.
February 16, 2011

If you’re like most Americans, chances are you have a number of unused credit cards. Lured by lucrative sign-up rewards bonuses or promotional 0 percent APR offers, most of us end up applying for credit cards we don’t really need. The result is often a drawer full of unused credit cards.

Americans cut back on credit card usage more than ever last year, in part to simplify their finances. However, even if you don’t use a credit card, you may want to think twice before closing the account, as it could have unintended consequences on your credit score.

But if you’re still determined to close your card, here are some important things that you will need to look out for in order to avoid inadvertently lowering your credit score.

Consider how closing a card will affect your credit utilization ratio

The FICO credit scoring system doesn’t carry a penalty for shutting down a card. However, canceling a credit card can have an indirect — and often negative — effect on your credit score if you’re not careful.

The most important thing to consider when closing a credit card account is how it will affect your total credit utilization ratio. Your total credit utilization ratio is the percentage of available credit that you have used across all credit cards. It counts toward about 30 percent of your FICO score and is second in importance only to paying bills on time, which accounts for 35 percent of your score.

When you close your card, it automatically lowers the total credit that you have available and, as a result, your credit utilization ratio may increase as well — even if your card doesn’t carry a balance. For example, consider a cardholder who carries three cards with $2,000 in balances across all cards and has approximately $10,000 worth of credit still available. The total credit utilization ratio in this case is $2,000/$10,000, or 20 percent — not great, but still acceptable.

Now, let’s say that the cardholder closes one of the credit cards, which has a zero balance and a $5,000 credit line. By closing the card, the cardholder has cut their total available credit in half to just $5,000. Now, suddenly, the cardholder’s total credit utilization ratio is $2,000/$5,000, or 40 percent — which is high enough to pull down the cardholder’s credit score, even though the cardholder’s debt load hasn’t changed one bit.

Calculate your ratio to determine whether your score will take a hit

In order to determine the impact that closing your account(s) will have on your credit score, you will need to first pull out your calculator and figure out what the resulting credit utilization ratio will be after closing the account(s). To do this, total the balances and the credit limits across all remaining credit cards. Then divide the total balance by the total credit limit to determine whether the resulting utilization ratio will be within an acceptable range.

How high can your credit utilization ratio go before affecting your FICO scores? Experts provide different numbers for the “ideal” credit utilization ratio. However, they generally agree that, for excellent credit, your ratio should be below 30 percent, both within each individual card and across all cards. And, preferably, it should be even lower. According to FICO spokesman Craig Watts, people with the highest credit scores have a total utilization ratio below 7 percent.

Increase your credit line
One way to prevent damage to credit scores is to increase the credit limit on the cards you plan to keep before closing a credit card. To do this, call your card issuer(s) to request a credit line increase. Most issuers will typically grant a line increase at least once a year for accounts in good standing.

On a positive note, according to myFICO.com, closing a credit card won’t have an immediate effect on the average age of accounts or credit history length. The account will continue to be counted for ten years; then it will disappear. So, in the very long term, this could draw down your score. However, the effect will be ameliorated by any other credit-building activities that you undertake in the meantime.

Don’t wait until a card issuer closes an unused account for you.
If you don’t close an unused credit card account, card issuers may do it for you. Increasingly, credit card issuers are taking steps to close down accounts that haven’t been used for a while – catching cardholders off guard. And it doesn’t matter whether you close the account or your card issuer does; it will have the same effect on your credit utilization score. To protect yourself and keep all lines of credit open, be sure to rotate credit cards so that they are all used regularly.