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Think Twice Before Canceling Credit Cards

You’ve worked hard and finally paid off the balance on one of your credit cards. Now, you should go ahead and pay off the balance and cancel the card, right?

Wrong!

You should think twice before canceling a paid off credit card. Closing a credit card account will negatively impact your credit score, especially if you’ve held the credit card for a long time.

Also, if you are about to apply for a loan or mortgage, a recent credit card cancellation could actually hurt your chances of qualifying.

There are two main ways that cancelling a credit card can hurt your credit score:

Number One – Cancelling a Credit Card Can Raise Your Ratio of Credit Card Utilization

Credit bureaus compare the amount of credit that you are using to your total available credit limits. In fact, credit card utilization accounts for up to 30% of your credit score. The lower your credit card utilization figure is, the better it is for your overall credit score. It’s best to keep your credit utilization ratio below 20%. If you cancel a credit card, then you are increasing the percentage of available credit that you are using because the credit limit for that card is cancelled too.

For example: Imagine that you have three credit cards with a $2,000 limit on each of them. On card number 1, you have a $600 balance. On card number 2, you have a $500 balance. On card number 3, you have a $50.00 balance. Your credit card utilization ratio is averaged across the three cards, so it would be ($600 + $500 + $50)/$6000 = $1150/$6,000, or a healthy 19% of your available credit.

However, let’s say that you decide to pay off card number 3 and cancel the card. Your credit utilization ration, now averaged across two cards, would now be ($600 + $500)/$4000=$1100/$4000, or about 28% of your available credit. Closing a credit card account caused your credit utilization score to jump quickly from an acceptable range (19%) to an unacceptable range (28%).

Number Two – Cancelling a Credit Card Affects Your Credit History

When it comes to your credit score, older debt is better than new debt. That’s because loan companies want to see that you have a long history of managing debt well. In fact, the length of your credit history accounts for up to 15% of your credit score. If your card history for a particular card shows a consistent pattern of payment over a long time, then usually you are much better off keeping that credit card account open.

What to Do Instead of Cancelling a Credit Card

Let’s say that you finally have a credit card almost paid off. A natural impulse would be to completely pay it off and close the credit card account. As we have shown, however, this may not be the best overall choice for your credit score.

An alternative to closing an account is to leave the credit card account open, but to make no new charges on it. (If you feel that the temptation to make new charges is too great, then you may wish to hide the card away to avoid using it.)

Guest post by Apex Credit Cards.

5 Comments »

  1. L Stone said,

    April 11, 2008 @ 2:19 pm

    You need to be more specific about the conditions under which you cancel a credit card and how it affects your credit report. This article seems to say that canceling any credit card that is paid off will hurt your credit report.

    Sounds to me like you’re just giving people a way to rationalize having credit card debt when they NEED to be paying it off and keeping it off. After all, your links and sponsors are credit card companies. You are hardly being impartial and you aren’t helping people who are already struggling to control their credit card usage.

    I was told by the big 3 Equifax, Transunion et al that closing zero balance credit card accounts HELPS your credit score.

  2. Serge the "Best credit cards" said,

    June 23, 2008 @ 4:43 pm

    L Stone seems to be angry on the whole world here. Let me get the situation a little bit more clear: the publisher of the article says that “pay the credit card debt off, just don’t cancel your card”. He doesn’t say “Keep your debt to improve your score”. L Stone should get into text better.
    Im absolutely agree with article publisher that canceling a credit card will negatively affect your credit score – i had my own experience with that. So the idea to pay it off and keep it is VERY good and useful advice. And websites like this (with a buch of links for credit cards) want their users be wise and take advantage of the system and keep their well being. I can say even more: having reasonable quantity of credit cards with 0 balance is helping your score. But a canceling is not so dramatic, but its a sign of unstable situation for credit bureaus.
    So L Stone, just educate yourself and don’t be so angry.
    Thanks.

  3. My Debt Refinance said,

    September 30, 2008 @ 6:19 am

    Great tip, specially the one talking about the importance of having old debts. Is also good to have a credit card with no charges in case of an emergency.

  4. Beckley said,

    November 19, 2008 @ 5:16 pm

    Apparently the playing field is now different. I did what you said. I’ve had a card with a $12,800 credit limit for many years in excellent standing, and for a while its had no balance.

    Today, I discovered that WaMu had closed the account, without any notice or authorization from me.

    When I called they told me that they were “reducing their exposure to risk” and that my account “cannot be reopened”.

    Simply evil.

  5. sudoku daily said,

    July 4, 2010 @ 12:34 am

    its good to have one card for emergenices, but running your life based on how good your credit score is, spells financial disaster, keep one card and pay cash, get rid of debt and dont go into any more period.

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