Some U.S. credit cardholders mistakenly believe closing credit cards will improve their credit score. In reality it could harm your credit score because it will likely change your credit utilization computation, lowering your score.
Credit utilization comprises about a third of your credit score, a major factor. In fact, credit utilization and payment history (late payments), combined, make up two-thirds of your credit score.
Furthermore, if you have had the card a long time it could change the length of credit history, which also impacts your score somewhat.
For example, lets say you owe $7,000 in total credit card debt but have $10,000 open or available on all your cards, your credit utilization ratio is 70%. If you close a card with $3,000 in available credit, the credit ratio will jump to 100%, significantly eroding your credit score.
Creditors like to see credit utilization ratio of less than 30%.
There are legit reasons why you may want to close a card, especially if the card carries a high annual or monthly fee. However, if the cost is minimal, you might consider stuffing it in your sock drawer for a rainy day. You might need some available credit to pay for the car alternator, which failed unexpectedly; the fridge that just died; or God forbid, the unanticipated root canal.
Our good friends at National Debt Relief, reinforce our thoughts about closing a credit card.
However, if you are dead set on closing a credit card account, NDR outlines four steps in the process:
1. Assess the Impact
Before you take the plunge and cancel a credit card, the first thing you should do is determine the effect that closing a credit card will have on your finances. Canceling a credit card (even one with a low balance) will almost certainly affect your credit score. Removing a credit card from your overall mix can potentially alter your credit mix and utilization, and change the computation of your overall credit score.
Additionally, canceling a card could limit your ability to respond to a financial emergency, such as when your car or home needs critical emergency service or you otherwise need funds quickly to address an unforeseen event. You should definitely consider these factors prior to taking any steps to close out one of your credit cards.
2. Pay the Balance Off
If you do decide to cancel one of your credit cards, the first thing you should do is pay off the balance. You can do this either by paying whatever balance is on the card, or by conducting a balance transfer to another credit card. When paying off the balance, ensure you also stop any programmed payments – for utilities, internet, or other services – that may be recurring on the card. Moreover, even after you think you’ve brought a card’s balance to zero, you can still end up with a small balance the following month due to interest expenses or fees that were incurred prior to your payment. So, verify no balance exists on the card you’re paying off in the following billing period, just to be on the safe side.
3. Contact the Credit Card Company
Once you’ve paid off your credit card’s balance, you should immediately contact the credit card company. A customer service representative can help you verify that the card is actually at $0 and that there are no remaining fees or interest expenses due to hit the card. Once you’ve verified that the card is fully paid off, inform the customer service representative that you’re canceling the card. In some cases, you may be able to cancel a credit card without ever speaking to a representative; the automated customer service systems lenders use often include an option to close out your credit cards. Finally, something important to keep in mind while you’re going through this process: when contacting your credit card company and discussing your account with representatives, always remember it’s your right to cancel your credit card whenever you want to do so.
4. Monitor Your Credit
Canceling a credit card will often have an effect on your credit. Once you cancel the card, monitor your credit closely to assess what impact the cancelation has had. There are many ways to do this. Many banks and financial service companies allow you to check your credit score whenever you want. Additionally, you can order a credit report free every year from annualcreditreport.com. If you do so a few months after closing out the card, you’ll be able to see exactly what effect that cancelation has had on your overall credit. In some cases, closing out your card may have no impact on your credit, or it may actually improve it. However, if you find your credit score has dropped substantially in the months after canceling your credit card, you’ll have a better understanding of what you’ll have to do in order to improve it.