When Should You Consider Closing a Credit Card Account?
There are plenty of reasons to fall out of love with a credit card. You never use it. It's got a bad interest rate. You put a picture of Elsa from Frozen on the card because you thought it would be funny, but it has not made a single transaction funny, only uncomfortable.
For whatever the reason, you may decide that it's time to close a credit card account and open up wallet space for someone new. But there are some notable drawbacks to closing a credit account, especially when it comes to your credit score. So before you say goodbye, consider the following and make sure that you're making the best decision for you and your credit.
Why does closing an account hurt your credit?
Closing an account you don't use or want may seem like a savvy credit move. After all, it's one less card for you to use poorly and fall into debt with.
Unfortunately, it's a bit more complicated than that. Each loan and credit card has an impact on your credit, not just as an individual account, but as part of your overall credit picture. Removing one account changes the overall landscape, which can have a negative impact on your credit score.
Shortened credit history
It's easy to keep an account in good standing for a few months. Staying in good standing for years (or decades) is much harder. That's why most credit scoring models factor in the average age of your accounts. Having older, established accounts looks positive to creditors. The higher the average age for your accounts, the better that reflects on you and your ability to use credit responsibly.
A lower average age, on the other hand, suggests that you're either new to credit or have recently opened new accounts. Credit scoring models take that to mean that you have less of an established track record with credit (at least with the accounts you currently have open).
So, closing a credit card, especially an older account, can significantly reduce the average age of your accounts, negatively impacting your credit score in the process.
Increased credit utilization ratio
Another important factor in your credit score is credit utilization ratio. It's basically a measure of how much of your total available credit that you're currently using. If you've got $1,000 in balances across multiple cards with a total credit limit of $10,000, your ratio would be 10%.
For credit scoring purposes, a lower ratio is preferred. The more available credit you have, the less likely it is that you'll max out accounts, become overwhelmed, and fall behind on your payments.
If you have any balance at all, closing an account will increase your utilization ratio. The available credit in the now-closed account goes away, but the balance remains the same, increasing the ratio even without adding any new debt.
When should you close a credit card (despite the hit to your credit)?
Of course, your credit score isn't the only important factor in your life. And truth be told, most kinds of credit damage are temporary. Over time, your credit will improve as you make timely payments and the age of your other accounts continues to increase.
There are some times when leaving a card open just isn't in your best interests.
The costs outweigh the benefits
Some credit cards cost money even if you never use them. There may be costly fees associated with your credit card that just aren't worth paying anymore.
Alternatively, maybe you do use the card, but the interest rate is too high or the rewards are not comparable to what you can get elsewhere.
Before closing a disappointing card, though, contact your creditor. Ask them to waive the annual fee. Ask if you're eligible for a better interest rate or a higher credit limit. They may be willing to make changes to the account to keep you as a customer. At the very least, be sure to see what they're willing to do before closing the account.
You need to focus on debt repayment
If you're struggling with credit card debt, your credit score is probably not your priority. Depending on how you decide to tackle your debt, you may need to close some or all of your credit card accounts.
Having less access to credit can be scary, but it may be necessary to finally get you out of debt. By closing accounts, you remove the option (and temptation) to add more debt, allowing you to focus fully on becoming debt free.
The rule of thumb with credit cards tends to be this: if it's not hurting you, keep it open. But if a credit card is costing you more than it's worth or is making it difficult to manage money responsibly or reach your goals, than it may be time to let it go...let it go...let it go.
Need help finding the best solution to your credit card problems? MMI offers free financial counseling, online and over the phone. Let us review your situation and provide tailored suggestions for the best way to solve your unique challenges.
