Think before canceling a credit card.
So, you want to cancel a credit card. Whether you should do so and how to complete the task isn’t always so simple, though. Canceling a card requires more than just cutting it up, and retiring that piece of plastic can be either a wise financial move or an unnecessary ding to your credit score. Here’s how to decide if you should keep or cancel your credit card, and how to close your account the right way if you decide to bid it farewell.
SHOULD YOU CANCEL YOUR CREDIT CARD?
Do you really need to cancel your credit card, or should you simply stop using it? This is the first question to ask yourself when deciding whether to close your account. Keeping your card open can help your credit score and provide flexibility in an emergency. Because of this, there are generally only two compelling reasons to cancel a card:
· You can’t control your spending and need to get rid of the temptation
· You’re paying an annual fee on a card you don’t use
The second question to ask yourself is how cancelling your card will impact your credit score. Leaving your card open can benefit your score in two ways: by improving your utilization ratio (which makes up 30% of your FICO Score) and by adding to the length of your credit history (which makes up 15% of your FICO Score).
Your utilization ratio is the total balance on all your credit cards divided by the total credit limit of all your credit cards. Keeping your utilization ratio under 30% is often recommended as being best for your credit score.
For example, if you had a balance of $500 and a limit of $1,000 on credit card A and a balance of $250 and a limit of $2,000 on credit card B, your utilization ratio would be 25% ($750 divided by $3,000). However, if you paid off and cancelled credit card A and kept that same $750 total balance on credit card B, your utilization ratio would increase to 37.5% since your total credit limit would shrink to $2,000 from $3,000. This would likely harm your credit score.
You could still cancel your card and avoid the problem above in one of two ways. You could reduce your utilization ratio by either paying down your balance or by requesting and receiving a credit limit increase from your credit card company.
The other way your credit card contributes to your credit score is by adding to the length of your credit history. Creditors like to see that you’ve had a long history of using credit, so the longer the age of your oldest credit account, your newest credit account and the average of all your credit accounts, the better. For this reason, cancelling one of your oldest cards, especially if you have a short overall credit history or few credit accounts, can harm your credit score.
Thankfully, if a credit card is cancelled in good standing (i.e. with no money owed), it will likely remain on your credit report and contribute to your credit score for at least ten years and possibly indefinitely. If a credit card is cancelled in bad standing (i.e. with an unpaid balance), it will remain on your report and impact your score for no more than seven years.
HOW SHOULD YOU CANCEL A CREDIT CARD?
If you’ve assessed your situation and decided to cancel your card, here’s how to do so:
1. Redeem any rewards you have on the card, and wait for them to be credited to you.
2. If you still have a balance on the card, pay it off in full, or transfer it to another card (but make sure you understand the associated fees and terms).
3. Call the customer service number on your card, confirm that the card no longer has a balance and request that the card be cancelled.
4. Check back a month later using your credit card website or the customer service number to confirm that the card has been canceled, and consider checking your credit report to ensure the account is recorded as closed.
HOW SHOULD YOU KEEP A CREDIT CARD OPEN?
If you’ve decided to leave your credit card open, make sure you keep using it at least semi-regularly. Credit card companies may close your card on their own if it isn’t used often enough. You can avoid this by making at least a small purchase with the card every couple of months.
For the greatest convenience, you can set the card to pay a recurring bill such as a Netflix subscription, then set up autopay for the card itself. Just make sure you keep a sufficient balance in your bank account to cover the autopay amount. You can then store the card in a safe place.
Deciding to keep or cancel a credit card may not be as simple as it seems, but with this information, you can make a smart decision. Thankfully, unless you’ll be applying for a mortgage or other loan in the near future, it’s usually safe to cancel a credit card if your credit score is strong. With credit that’s already on good footing, the effect of closing a card is typically minimal and temporary. This content is provided for general informational purposes only. Draper and Kramer Mortgage Corp. does not provide credit advice. Please consult your credit advisor for advice on your specific situation.