Why Does Closing a Credit Card Hurt?
Learn why closing a credit card often has unintended negative consequences for your credit score. Understand the financial impact.
Credit cards offer convenience for purchases and help establish a credit history. This history is fundamental to an individual’s financial standing, influencing access to loans, interest rates, and other financial products.
Understanding Credit Score Components
Credit scores are calculated based on several key factors. Payment history carries the most weight, accounting for 35% of a FICO score, reflecting whether bills are paid on time. Amounts owed, also known as credit utilization, is another significant factor, contributing about 30% to the score.
The length of credit history makes up approximately 15% of a FICO score, considering the age of accounts. New credit, representing recent credit applications and new accounts, accounts for about 10% of the score. The credit mix, which evaluates the diversity of credit types, such as credit cards and installment loans, contributes roughly 10%.
How Closing Affects Credit Utilization
Closing a credit card can directly impact your credit utilization ratio, which is the amount of credit you are using compared to your total available credit. When an account is closed, the credit limit associated with that card is removed from your overall available credit. If you maintain balances on other credit cards, this reduction in total available credit can cause your utilization ratio to increase.
For instance, consider someone with $1,000 in balances across two cards, each with a $5,000 limit, totaling $10,000 in available credit. Their utilization is 10% ($1,000 / $10,000). If one $5,000 limit card is closed, the total available credit drops to $5,000, and the utilization jumps to 20% ($1,000 / $5,000). A higher credit utilization ratio is often viewed less favorably by credit scoring models, potentially signaling a greater reliance on debt. Financial professionals generally suggest keeping your overall credit utilization below 30%, as exceeding this threshold can begin to negatively affect credit scores.
How Closing Affects Credit History
Closing a credit card can also influence the length of your credit history, particularly if it is an older account. Credit scoring models assess the average age of all your credit accounts, with a longer average indicating a more established credit profile. A closed account in good standing remains on your credit report for up to 10 years, continuing to factor into your average age of accounts. However, its eventual removal can shorten your overall credit history.
This means that the positive influence of that long-standing account on your average age of accounts will diminish over time once it is no longer on your report. A longer history of responsible credit use is generally seen as a positive indicator of financial reliability. Therefore, removing an older account can, in the long term, reduce the positive impact of a lengthy credit history on your credit score.
Factors to Consider Before Closing
Before deciding to close a credit card, evaluate several factors to mitigate potential negative impacts on your credit score. The age of the account is a key consideration; older accounts contribute positively to your credit history, so closing your oldest accounts is not advised. Another factor is whether the card carries an annual fee. If the benefits and rewards do not outweigh the annual fee, consider closing it or downgrading to a no-annual-fee version with the same issuer.
The credit limit of the card also plays a role. Closing a card with a high credit limit can significantly reduce your total available credit, increasing your credit utilization ratio if you carry balances on other cards. Issuers may close cards due to inactivity, which can also affect your utilization. Making small, occasional purchases on such cards and paying them off can help keep them active. Closing a card is best reserved for situations like managing overspending habits or addressing fraud concerns.