How Bad Does Closing a Credit Card Hurt Your Credit?
Thinking of closing a credit card? Understand the nuanced impact on your credit score to make the best financial choice.
A credit score is a numerical representation of an individual’s creditworthiness, typically a three-digit number ranging from 300 to 850. Lenders use these scores to assess the risk of lending money, influencing decisions on loan approvals, interest rates, and credit limits for mortgages, auto loans, and credit cards. A higher credit score generally leads to more favorable loan terms and lower interest rates, which can result in significant financial savings over time. Understanding how various financial actions, such as closing a credit card, can impact this score is important for maintaining strong financial health.
Understanding Key Credit Score Factors
Credit scores are calculated based on information within your credit reports, with several key components determining the overall score. Payment history is a primary factor, reflecting your record of on-time payments for all credit accounts. Consistent, timely payments positively influence your score, while missed or late payments can significantly reduce it.
Credit utilization is another important component, representing the amount of credit you are currently using compared to your total available credit. Maintaining a low utilization ratio, typically below 30%, is generally seen as responsible credit management. The length of your credit history also plays a role, with longer histories often indicating more experience managing credit.
Additionally, your credit mix, which refers to the variety of credit accounts you hold (e.g., credit cards, installment loans, mortgages), demonstrates your ability to manage different types of debt. Lastly, new credit applications, especially multiple hard inquiries in a short period, can temporarily impact your score. Both FICO and VantageScore, two widely used scoring models, consider these factors, though their specific weighting may vary.
Impact on Credit Utilization
Closing a credit card can directly influence your credit utilization ratio, which is a significant factor in credit scoring. When a credit card account is closed, the credit limit associated with that card is removed from your total available credit. This reduction in available credit can cause your utilization ratio to increase, even if your outstanding balances remain the same.
For example, if you have a total credit limit of $15,000 across multiple cards and a total balance of $3,000, your utilization is 20%. If you close a card with a $5,000 limit, your total available credit drops to $10,000, instantly raising your utilization to 30% with the same $3,000 balance. A higher utilization ratio signals increased risk to lenders, potentially leading to a decrease in your credit score, especially if it rises above 30%.
Impact on Length of Credit History
The length of your credit history is another factor that can be affected when you close a credit card. A longer credit history with responsible management generally contributes positively to your credit score.
When you close a credit card, especially an older one, it can reduce the average age of your open accounts. Closed accounts with positive payment history can remain on your credit report for up to 10 years, but closing your oldest account can still shorten your overall credit history length. Therefore, closing a long-standing account, even if it was in good standing, can have a more detrimental effect on this aspect of your score compared to closing a newer account.
Strategic Considerations for Closing a Credit Card
Deciding whether to close a credit card involves weighing potential benefits against the risk of impacting your credit score. Sometimes, closing a card is a practical choice, such as when dealing with a card that carries a high annual fee that no longer justifies its benefits, or if you are trying to curb overspending. Simplifying your financial accounts or transitioning to a card with better rewards or lower interest rates can also be valid reasons.
To minimize negative impacts if you choose to close a card, consider paying down balances on your other credit cards first to lower your overall credit utilization. It is also generally advisable to avoid closing your oldest credit card, as this can disproportionately affect the average age of your accounts. If you must close an account, ensure its balance is paid in full before requesting closure.
You can also explore alternatives to closing a card, such as downgrading to a no-annual-fee version of the card or simply using the card sparingly for small, recurring purchases to keep it active and maintain its positive history. Monitoring your credit report after closing an account can help ensure accuracy and allow you to address any unexpected score drops.