3 guidelines that will help you know when canceling a credit card will barely affect your credit score and when it can do some damage.
Danny P. asks: I have 5 credit cards with zero balances and a total of $7,500 available credit. I just use one card and pay it off in full every month. One of the other cards has a low $200 credit limit. Would it be a good idea to cancel it?
Whether it's smart to close a credit card or not is a common question because many people know that it can hurt your credit score. But we also want to lighten our load and ditch the cards we don't use. Here are 3 guidelines that will help you know when canceling a credit card will barely affect your credit score and when it can do some damage:
- What is the credit limit of the card?
When it comes to lines of credit and credit cards, the amount you owe for all your accounts compared to your total credit limit is very important. The wider the spread, the better. It's recommended that you never carry a balance that exceeds 30% of your available credit.Think about what happens when you cancel a credit card.Let's say you have 2 credit cards and each have a $5,000 credit limit and you owe $2,000 on card A and nothing on card B. That's a total credit limit of $10,000 and a total owed of $2,000, or a credit utilization of 20% ($2,000 / $10,000 = 0.20). If you cancel card B because you just paid it off, you still owe $2,000 on card A, and your available credit shrinks to $5,000. Canceling your card shot your utilization ratio up from 20% to 40% ($2,000 / $5000 = 0.40), which can lower your credit score. The lower your credit limit on a card, the less closing it could negatively affect your credit score. Since the card that Danny wants to cancel has a small credit limit that only makes up 2% ($200 / $7,500 = 0.02) of his total credit, closing it shouldn't have any negligible affect on his credit score.
- How long have you had the card?
The length of your credit history plays an important role in how various scoring models calculate your credit score. If you close a card, positive credit transactions stay on your credit report for 10 years and any negative transactions remain for 7 years. But after that time all the account information disappears.So think twice about canceling a credit account that you've had open for many years.
- Do you have another credit card?
Having a mix of credit types--like installment loans and lines of credit--is a factor in how credit scores are calculated.So don't cancel your only credit card. You need to have at least one credit card in good standing.