Q&A: Will closing a credit card lower my credit score?

Question: Will closing a credit card lower my credit score?

Answer: This is one of the most common questions people have about their scores. It would seem logical that closing an account, which decreases your access to credit, might have a positive affect on your score. But guess what? The opposite is often true.

But let's be clear about one thing: It's really impossible to predict how one action will impact someone's score because we all have a different history and different line items on our reports. But in most cases, closing a credit card account will decrease your score at least a little.

One of the reasons why is because you have what's called a credit utilization ratio. This is the amount of credit you've used compared to the amount of credit you have available. The FICO score takes a close look at this and it's about 30 percent of your score.

Here's an example: Let's say you have two cards and they each have a $1,000 credit limit. So your available credit is $2,000. On Card #1, let's assume you have a $400 balance (the amount of credit you've used). And let's also say that you have no balance at all on Card #2.

Your utilization ratio is: 400/2,000 = .20, or 20 percent. A ratio under 30 percent is very good. But if you're trying to build up your score quickly, keep your ratio below 10 percent.

Now, if you close Card #2, your ratio jumps up because you've lost $1,000 of available credit. Here's the new ratio: 400/1000 = .40, or 40 percent, which is high enough to lower your score, in most cases. So this is how closing a credit card might cause an increase in your utilization ratio, which in turn, can decrease your score.

But if you still want to close the card because there's something objectionable about it, such as a high annual fee, then there are a few steps to take before you close your account that might lessen the impact on your score.

Ask for a credit limit increase on another card. The purpose here is to increase your available credit to soften the blow to your score. Be sure you ask for an increase that helps replace the limit that you'll be losing. If you have an excellent track record with your card company, then consider asking for even more that the replacement value. This might even help improve your score.

Pay down your balances. This targets the amount of credit you've used. If you decrease that amount, then your ratio will go down. If you can wait a few months before closing your account and work on paying down the balances, this can help keep your ratio low and protect your score.

Apply for a new card. This is only a good idea if you really do need another card and you don't have a problem with overspending. If you do get a new card before you close the old one, then you've replaced the available credit you had.

Once you have a grasp on how the utilization ratio works, you can really use it to your advantage. But remember that if you're applying for a new loan anytime soon, it's best to wait until after you get approved for it before you close an account. Even if the impact on your score is small, it could be enough to kick you into a higher rate on a mortgage.

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