To many consumers, scores are a bit of a mystery. One reason scores are so confusing is because it's difficult to predict how a specific action will impact your score. The effects of closing a credit card account are especially hard to predict because there are so many factors involved.
The bottom line? Closing a card account is likely to lower your score. How much it decreases, if at all, depends on what else is in your credit report. Let's take a look at the details and you'll get a better idea of how your own score might be affected. Not sure what your score is? Get your credit score free with us.
Why closing an account is an issue
Many folks worry most about how closing an account will impact the length of their credit history. Your credit history is important, but there's unlikely to be an immediate impact. A closed account can stay on your credit report up to 10 years. So it's not an immediate concern.
What you really need to pay attention to is the amount you owe on your credit cards. According to myFICO.com, there are five major factors that are considered when your FICO score is calculated:
- Amounts owed (30 percent)
- Payment history (35 percent)
- New credit (10 percent)
- Length of credit history (15 percent)
- Types of credit in use (10 percent)
Note that "amount owed" is a whopping 30 percent.
You have what's called a "credit utilization ratio," which is the amount of credit you've used compared to the amount of credit you have available. A good ratio is 30 percent. An outstanding ratio is 10 percent. If you close a credit card account, you lose the available credit associated with that card. This, in turn, causes an increase in your utilization ratio. When your ratio increases, your credit score decreases.
How to minimize the impact on your score
The amount of the decrease (anywhere from zero on up) depends on the specific details in your credit report. But there are four things you can do to minimize the negative impact of closing a credit account on your score.
- Ask for a credit limit increase on another card. -- This will help to offset the lost "available credit" on the card you're closing. For example, if the card you close has a $1,000 credit limit, then you need to replace that amount. Ask for a $1,000 increase in your limit on another card. If you have several cards and you don't feel like it's possible to get that big of a credit limit, then ask for a smaller increase per card, but try to make up the $1,000 difference as much as you can. (This is a good time to note that you'll have a better chance of success if you have been an excellent cardholder with a great payment history. If not, then bringing your account to the issuer's attention could have the opposite results. You could actually end up with a lower credit limit. So be sure your account is in good shape before you attempt this.)
- Make sure the balance is zero. -- If you close an account before paying it down to zero, it will look like you've spent up to your credit card limit. So pay the balance in full before you try to close it. Otherwise, it can make your ratio look like it's 100 percent for the card you're closing. Pay the bill in full and then follow up with your issuer. Check your balance online to confirm the balance is zero before you make the call to cancel it. When you chat with the customer service rep about canceling the card, confirm it one last time.
- Get a new card before closing it. -- This helps your ratio the same way that increasing your limit will help. You get a new amount of available credit to boost your ratio. The key is to get your new card before you close the old card.
- Pay down other card balances first. This approach is a win for you. You need to pay down your balances anyway, so here's an incentive to do it as quickly as possible. Take a look at your balances and calculate your ratio. Keep an eye on it as you work on decreasing the amount you owe.
When it makes sense to close a card
Sometimes you're better off taking a hit to your score rather than hanging on to a credit card that's messing up your financial life. For instance, if you're a shopaholic, then you need to decide if cutting up your cards is enough to stop your spending. It's easy to hop online and retrieve your account numbers. So if incapacitating your card doesn't stop you from online spending, you might need to close it.
Credit card debt is toxic debt. You pay a lot of interest when you carry a balance. With some debt, such as a mortgage, the debt is an investment. You expect (and hope) the value will rise. But this isn't so with credit card debt. As the debt grows, you'll lose a ton of money paying interest. So if you need to cancel the card to keep your financial life intact, then do it.
Another example is a card with a high APR or large annual fee. If you have a high APR and you have a balance, think about using a balance transfer credit card to take the money owed on one card, and put it on another with a zero percent introductory APR. This will give you a break from paying interest for a specific period of time. Pay down your card as much as you can during the intro period.
You can choose to keep your old card open if you feel confident you won't carry a balance. Having a high balance on your new card will impact your score, however, when you're in credit card debt, the priority needs to be paying off that debt. You can work on your score after you've accomplished that.