When you start paying down your debt, one of the first impulses you are likely to have is to cancel each credit card as you pay it off. Even if you already have most of your debt taken care of, you might want to cancel a credit card you don’t use anymore, or that you don’t like.
Before you cancel any credit card, however, it’s important to think through your decision and make sure it’s the right decision for your finances and your credit score.
Will Canceling a Credit Card Hurt Your Credit Score?
First of all, it’s important to understand the impact that canceling your credit card will have on your credit score. When you cancel your credit card, there is a chance that you could lower your credit score.
Here’s why. If you have debt, canceling your recently-paid-off card will immediately increase your credit utilization. The term “credit utilization” refers to the percentage of your available credit that you are using right now. For example, if you have two credit cards and each one has a credit limit of $10,000 then your total available credit would be $20,000. If each of those two credit cards had a balance of $1,000, then your credit utilization would be 10% ($2,000 out of $20,000).
In general, the higher your credit utilization is, the lower your credit score will be. That’s because creditors don’t want to lend money to someone who has already used up all the credit that’s available to them. That’s why it’s recommended that you keep your balances to less than 30% of available credit This has a big impact on your score, too, because credit utilization accounts for almost one-third of your credit score.
Here’s a quick illustration of how canceling a credit card can boost your utilization. Say you have three credit cards:
Credit Card A has a limit of $3,000 and a balance of $800.
Credit Card B has a limit of $2,500 and a balance of $2,000.
You just paid off Credit Card C, so it has a limit of $2,800 and a balance of $0.
Right now, your credit utilization is right around 34 percent ($2,800 out of $8,300). However, if you cancel the card you just paid off, then the story changes. All of a sudden your credit utilization would be about 51 percent ($2,800 out of $5,500). So in this example, canceling your credit card would probably hurt your credit score because your credit utilization would go up dramatically.
The other way that canceling your credit card can impact your credit score is related to the length of your credit history. The amount of time that you have had credit is recorded on your credit report. Each credit account has an age attached to it, and the total age of your accounts is averaged. The longer you have had a credit account, the better your credit score is likely to be.
If you cancel your credit card, especially if it is one of your oldest credit cards, you are suddenly reducing the average age of your credit accounts. Length of credit history accounts for 15 percent of your credit score, so it could have an impact. If you combine your new lower average account age with a higher credit utilization number, you might be surprised at how much your score could drop.
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Does It Matter If You Have a Lower Credit Score?
Of course, you need to decide if it matters whether or not you have a lower credit score right now. If you are concerned that the temptation of having an open credit card with a lot of money “available” could tempt you to fall into debt, then it would make sense to cancel the card and avoid falling into that trap again.
After a few months, as long as you are responsible with your other credit cards and work to keep up with your obligations and pay your other debts down, your score should recover. If you aren’t planning to apply for a mortgage, auto loan, or any other large loan in the next six months, and if your insurance policy isn’t up for review (some insurers check your credit to set premiums) anytime soon, then canceling the credit card might not be a bad idea.
However, if you know that you will have your credit checked relatively soon, it may be a good idea to wait to cancel your credit card. That way, your credit score will get a boost from the fact that you’ve paid off the card but haven’t put more debt on it, and you will be helped in your efforts instead of hindered.
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This post was published by Miranda, ReadyForZero Writer for » ReadyForZero.
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