So you're guilty of opening up one too many credit cards. We’ve been there.
Maybe that one cashier was a little too convincing with their store credit card pitch. Or, the constant chase for the best deals and rewards might have caused you to apply.
It is easy to see where this might create a problem. Too many credit cards can make it easy to miss payments and manage your funds.
While closing a credit card might make sense in some cases, it is hardly a good decision for all credit cards. There is a hidden consequence of closing a credit card: it will hurt your credit.
This logic is not absolute for all credit cards Some credit cards might have high annual fees when you do not use them, which might warrant canceling.
For people with a low credit limit or with a limited credit history, closing a credit card could be an even worse idea.
Reasons People Consider Closing a Credit Card
High Annual Fees
Some credit cards come with high annual fees, ranging way into the hundreds of dollars. They usually provide a host of benefits to the cardholder. Yet, the utility of these benefits depends largely on who you are and your spending behavior. For example, having a travel credit card when you do not travel often may be less worth it.
Annual fees can be pricey, especially if you do not use a credit card very often and have found a better alternative.
Another hidden danger to having too many credit cards is juggling multiple interest rates. Credit cards can come along with high-interest rates (typically higher than a car or home loan).
Having multiple balances left on multiple credit cards will cause you to pay multiple interest rates.
Does Canceling a Credit Card Hurt your Credit Score?
So, if having so many credit cards can put you in a sticky situation, shouldn’t you close some of them? Not exactly.
Closing your credit card can hurt your credit score.
Credit Utilization Ratio
When you are issued a credit card, you are given a credit limit by the credit card company. This might be $1,000, $5,000, or more. A credit card company measures and reports how much of that credit you are using.
For example, you might be issued a credit card and are using $2,500 of a $5,000 credit limit. In this case, you are using 50% of your available credit. This 50% is known as your credit utilization ratio.
Having a lower credit utilization ratio is key to having a higher credit score. Closing a credit card can cause your credit utilization ratio to increase due to having your overall credit limit decrease against your current borrowing. Let’s take a look at an example:
Let’s say you have two credit cards. With one of them, as before, you are using $2,500 of a $5,000 credit limit. You also have another credit card with a $5,000 credit limit, but you are using $0 of it. In total, your overall credit limit is $10,000, but you are only using $2,500 of the credit. As a result, your credit utilization ratio is 25%.
Now comes the tricky part. Perhaps you are considering closing out that $5,000 credit limit credit card that you are currently using $0 of. So, you cancel it, and you are back to just having a $5,000 credit limit with $2,500 of usage. Your credit utilization ratio is back to 50%. In essence, by closing your credit card, your credit utilization ratio went from 25% to 50% just by closing your card.
The ideal credit utilization ratio depends on many things. Up to a 10%-30% credit utilization ratio is considered the best way to get the best credit scores from the credit utilization ratio.
Since credit utilization ratio increases are bad, closing your credit card is theoretically also bad. While there might be reasons to do so in certain cases, closing your credit card will not positively affect your credit as a result of this credit utilization increase.
Length of Credit History
Credit card companies also record the age of credit on credit cards, forming a part of your credit score. If you have a credit card whose bills you consistently pay, this helps your credit score - and the longer you do this, the better your credit.
Credit scores are influenced by the age of your credit. They take the average age of all of your credit accounts and consider them when calculating your credit score.
In the long run, closing a credit card account should not be too much of a concern. However, in the short run, closing out a credit card can negatively impact your credit score due to the change in the length of credit.
So, if you are planning on taking out a car loan, home mortgage, or even applying for an apartment, we would not recommend closing your credit card before then.
Over time, it becomes clear to lenders and to your credit score that canceling a credit card does not mean that you took on increased debt. This will take time to be reflected in your overall score, so make sure you understand the consequences before making an move to cancel.
Is It Bad to Close a Credit Card?
Closing a credit card might seem like a naturally good decision to make. When you do not use a card, or it is not comparatively beneficial to other cards (*cough cough* Extra) to make purchases with, you might consider closing a credit card. Remember, closing a credit card does hurt your credit.
How much does closing a credit card hurt your credit score? Well, that depends on many different factors, like your credit utilization ratio and the age of your credit.
When deciding whether you should close your cards, weigh the differences in why you are closing the card and how it could affect your credit score.