Not sure if you should cancel a credit card? Laura answers a listener question and gives you five questions to ask that will help you know whether closing a credit card will barely affect your credit scores or end up hurting your finances.
Before you cancel a credit card here’s what you need to know: it dramatically increases your credit utilization.
Canceling a credit card causes your available credit on the account to plunge to zero. That means your total balances become a higher percentage of your total credit limits, which makes you look riskier, even if you really aren’t. Your utilization ratio spikes and your credit scores can drop right away.
Let’s say you have 2 credit cards and each have a $1,000 available credit limit. If you owe $500 on card A and zero on card B, you have a total limit of $2,000 and a total owed of $500, which is a utilization of 25% ($500 / $2,000 = 0.25).
If you cancel card B because you just paid it off or just don’t like it, you still owe $500 on card A, but your available credit shrinks to $1,000. Canceling the card shoots your utilization ratio up from 25% to 50% ($500 / $1,000 = 0.50), which can instantly lower your credit scores.
For this reason, I strongly recommend that Stephanie keep her existing credit card open. And depending on her situation and goals, it may be best to keep the card even after she gets a new one.
5 Questions to Ask Before Closing a Credit Card
How you answer the following 5 questions will help you know whether closing a credit card will barely affect your credit scores or cause a lot of damage:
Question #1: What’s the credit limit of my credit card?
As I previously mentioned, if you want optimal credit, never carry a balance that exceeds 20% of your available credit limit. So the lower your credit limit on a card, the less closing it could negatively affect your credit.
Stephanie didn’t mention the available limit on her card, but if it’s more than $1,000, I’d recommend erring on the side of keeping it rather than getting rid of it.
Question #2: How long have I had my credit card?
In addition to making payments on time and keeping a low credit utilization ratio, the length of time you’ve used credit plays a role in how your credit scores are calculated. Having a long, rich credit file boosts your scores and makes you appear less risky to potential creditors.
If you close a card with positive history, it stays on your credit report for 10 years. Accounts with negative, late payment history remain for 7 years.
After these time periods expire, accounts disappear from your record, which reduces your overall average credit history. So think twice about canceling a credit account that you’ve had open for many years, especially if it’s your only card.
Think twice about canceling a credit account that you’ve had open for many years, especially if it’s your only card.
Stephanie mentioned that the card she’s considering closing has been open for 14 years. Because she’s had it for so long, it’s an important part of her credit file.