Credit scores impact our financial lives in big ways. Taking on debt, like a new car loan or a mortgage, requires a favorable credit score. Likewise, renting a home, getting insurance, or even applying for a job requires good credit. Making changes to your credit profile, like closing a credit card, requires careful consideration.
A common question we hear from clients at the Center for Financial Health is, “Should I close a credit card I’m not using?” The simple answer is “yes.” Spending our hard earned money paying down debt prevents us from saving and building wealth. However, there are several factors to consider before closing a credit card, like how long you’ve been using credit, and whether or not you’ll need to borrow money in the near future.
Closing a credit card that has an annual fee, or closing one that you never use is a good idea as long as you don't need to borrow money in the near future, and the card has a zero balance.
Although many factors go into scoring your credit profile, closing a credit card may impact your credit score in the following circumstances:
1. If you have balances on the card or other credit cards.
You can’t completely close a credit card until the balance is zero and your credit scores are impacted by the amount of credit still in use once a card is closed. This is because credit bureaus factor your scores, in part, by considering your credit utilization ratio or your balance-to-limit amounts. Credit utilization ratios compare the amount of credit being used (your current balances) to the total credit available (the maximum amount you may borrow). If you close a credit card with a high limit, but leave another credit card open that is maxed out (there is no credit available), your scores will likely be impacted negatively, because your credit utilization ratio is high.
2. If you’ve only been using credit for a few years.
Your credit score is determined in part by how long you’ve been using credit or more specifically, it is determined by the age of your credit card combined with other types of debts appearing in your credit profile. Closing out a credit card that you’ve just recently opened, while having an overall credit profile that is relatively new may impact your credit scores in a negative way.
3. If you have only a few trade lines.
The fewer trade lines (open, active accounts) you have, the more likely closing a credit card will impact your scores. The longer your credit history, and the more varied types of debts you’ve had, the less your score will be affected by closing a credit card.
If you’re thinking of closing a credit card, assess your current credit profile first before taking action. If you think you may need to borrow money in the near future, it may be a good idea to hold off closing any open, active accounts.
The good news is that credit scores are only a snapshot of your borrowing history. Although closing a credit card today may affect your credit score negatively, it should be temporary as long as you continue paying your bills on time and manage your credit obligations responsibly. For more information about credit scores, visit Experian's website at www.yFICO.com.
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Denise Keiser is a leader, mentor, and trainer specializing in money and housing with 20 years of experience in real estate and finance. She is seen on TV as the “Money Expert” for WLNS-6 Lansing’s “Money Monday” where she provides weekly money tips. Denise currently serves as the executive director of the Center for Financial Health, a Lansing-based nonprofit that inspires a lifelong commitment to financial wellness.