Why you should not close your credit cards!
Do you still remember the time when you got your first credit card?
Years later, you have several cards in your hands with a few old ones that have been collecting dust for a while. You might be familiar with the temptation to cancel those unused cards. But should you? The short answer is NO.
While it may seem like a good idea to cancel unused credit cards, this will harm your credit scores.
To determine your credit scores, the credit bureau evaluates five factors: payment history, the total amount owed, length of credit history, types of credit, and new credit. If you don’t know what your credit score is you can retrieve your credit profile for $1 with MyScoreIQ.
Payment history indicates whether you pay your obligations on time, and it makes up 35% of the overall credit score.
The total amount owed makes up for 30%, taking into account the percentage of credit available that is currently being used, known as the credit utilization ratio. To determine your credit utilization ratio, add all of your credit cards together. Add up all the outstanding balances first, then the credit limits of each card. Divide the total outstanding balances by the total credit limit, and multiply by 100 to get the percentage amount: the lower the credit utilization ratio, the better. Okay I know that was a lot, MyScoreIQ will tell you what your utilization is after you sign up.
Length of credit history shows how long you have had your credit opened and is 15% of the overall score. It is impacted by the age of your oldest account, your newest account, and the average age of all your accounts combined. That average age of your accounts is your “credit age”: the older the credit age, the better. Longer credit history is considered by lenders as less risky, especially if it shows a consistent track record of paying bills on time.
There are three types of credit accounts that can impact your credit scores: revolving (e.g. credit cards), open, like utility bills, and installments, such as car loans or mortgages. Although having various credit accounts is good for your credit health, it’s not the most important factor in determining your scores as it only makes up for 10%.
New credit accounts for 10% of the score. It factors in how many new accounts you have, how many times you have recently applied for new accounts, which can result in credit inquiries, and when the last account was opened.
Why should you keep your unused credit cards open?
Canceling your unused credit cards directly affects two of the five factors mentioned: credit utilization ratio and length of credit history.
Unutilized credit cards reduce your utilization ratio, which then improves your credit score. Most experts advise keeping the utilization ratio below 30%. The lower the utilization ratio, the better. So what will happen when you cancel your unused credit card?
Please see the illustration below:
The 3-year old unused card has a $0 balance with a $7,000 credit limit.
| Total Available Credit | Total Outstanding Balance | Utilization Rate | |
| Before Cancelation | $27,000 | $7,000 | 25.93% |
| After Cancelation | $20,000 | $7,000 | 35% |
After canceling the card, the utilization rate shoots up to 35%, which is above the 30% threshold. This would likely lead to a lower credit score.
In addition, the account stops aging after cancelation. This can cause the average age of all of your accounts (credit age) to fall which can have a negative impact on your credit score. Remember, the longer the credit history, the better. The damage could be even worse if the closed account is one of your oldest.
When is it okay to cancel/close your unused credit cards?
Suppose you have two credit cards一one with no annual fee, and one with an annual fee一from the same issuer, and you want to close the one with the fee. In that case, you may request to transfer the credit limit to your other card before closing the account. This way, your total available credit will not be affected. As a result, your utilization rate remains the same. As long as the canceled card is not one of your oldest accounts, it will not have a significant impact on your credit score.
If the annual fee is your only concern, try to negotiate with your issuer first to waive or lower it. We have listed 5 credit cards with annual fee of less than $100 here.
Having a good credit score is vital in today’s world. Your credit score indicates your overall financial health. It shows lenders how responsibly you utilize credit at a glance.
The higher your credit score, the easier it will be to get additional loans or lines of credit. When you borrow, a better credit score can help you get the best possible interest rates.
If you want to improve your credit score, it’s important to consider the factors that may affect it.
