Increasing your credit score can seem like a complicated process; after all, it’s created by an intricate algorithm that weighs each and every item on your credit report in a variety of different ways. And because many blogs and financial extremists tout all credit as bad, you might be tempted to close all of your credit cards in order to boost your score. But before you do, stop what you’re doing and find out how exactly closing a credit card affects your credit score. It’s not as cut and dry as you might think, and you might actually end up hurting your score by deciding to close any or all of your accounts. So take a closer look at the consequences before you choose the best next step for your situation.
Does closing your credit card hurt your credit score?
Credit cards affect your credit score in a couple of different ways. In the long-term, your credit score is partly determined by the age of all your revolving credit accounts. So when you look at all of the credit cards listed on your credit report, you can average how many years each one has been open. The older your accounts, the higher your score will be in this category. In fact, 15% of your score depends on how old your accounts are. This is an easy category to score high in because it’s not dependent on any other type of financial decision you’ve made — as long as you have taken the time to accrue a substantial credit history.
Consequently, when you close a credit card, you limit the number of accounts used in the calculation. It doesn’t happen automatically; in fact, each account continues to age for ten years after it’s been closed, before finally dropping off your credit report at the end of that period. So your score won’t drop right away; even if you close a brand new card, it will be ten years old by the time it falls off your report. If you’ve opened any new cards since then, your score will take a dip because the average age of your accounts has decreased.
Another way you can damage your credit score by closing a credit card is your credit utilization ratio. This term refers to the amount of debt you owe compared to the amount of credit available to you. For example, if you owe $2,000 on a credit card, but have three different cards with limits totaling $10,000 then your credit utilization ratio is 20%. But if you close one of those cards that has a $3,000 limit, you bring your total available credit down to $7,000. When you recalculate your credit utilization, it jumps up to 28.5%. Having a higher credit utilization not only affects your credit score, it also sends up a red flag to lenders that you may not have a lot of credit left to use.
How many credit cards should you have?
There’s no definite answer to this question and it largely depends on how you handle your credit cards. If you keep low or zero balances on your account, particularly compared to your overall limits and the amount of income you earn, having several cards won’t affect your credit too much or your ability to get a loan or mortgage. In fact, having more than one card lowers your credit utilization ratio because you have more credit available to you — as long as you don’t charge up the cards too much.
Having several credit cards, can, however, decrease your score if you open too many accounts in a short period of time. Part of your credit score is determined by “new credit,” accounting for a full 10%. Each time you open a new credit card or apply for a loan, it shows up in the “Inquiries” section of your credit report and stays there for two years. Your credit score will also take a dip for one year after each inquiry. If you just open one account, the drop won’t hurt your score too much. But if you open a ton of cards at once, you could potentially do some real damage to your credit score. Remember that retail cards at store chains also count in this section, so be wary of opening several accounts just to get a small discount or one-time bonus at a store you rarely visit.
Finally, another 10% of your credit score considers the different types of credit you have. If you have several credit cards or other types of revolving credit, but little or no installment loans like a mortgage or car payment, your credit score could suffer even more. Installment loans are weighted more favorably than revolving credit so it’s not good to overload on the number of credit cards you have, especially if you don’t have any installment loans at all.
Which accounts are best to close?
When you do decide to close one or more accounts, there are a few considerations to take into account in order to have the best effect on your credit card. First, think about closing your newest accounts. That way, your overall age of credit won’t take a big dip when the card comes off in ten years. If you tend to carry balances on your credit cards, you can also close the card with the highest interest rates. Of course, you’ll need to pay off the card in full before you close the account. In the event you do have a balance, you could try transferring it to a low-interest card or even a card with a 0% introductory rate. Just be sure you can pay off the balance before the introductory period ends, otherwise you could potentially end up paying an even higher interest rate than before.
Other good card candidates to consider closing include any with an annual fee. Perhaps the first year’s fee was waived for new customers and you received some sort of rewards point bonus. Of course, if your rewards program is lucrative enough that it more than pays for the annual fee, you don’t necessarily want to close this one. But if you rarely use the card and don’t take advantage of any member benefits, then it may be time to close the account rather than paying to have the card sit in your wallet.
Similarly, any card that doesn’t offer any benefits or rewards could be a good one to close. You’ll want to consider any detrimental effects it might have on your credit utilization, but if you have decent credit today, you should be able to find a credit card that offers some types of rewards program you can use. Just remember that points are typically only rewarded after the card balance is paid off each month, so this isn’t an important factor for someone who regularly carries a balance.
What’s the best way to close a credit card?
When you do decide to close a credit card, go into it with a smart strategy to minimize any damage to your credit score. If you’re closing more than one account, try to space them out over time. That way your credit utilization ratio won’t drop overnight. The same advice applies for opening up new credit cards since each new account causes a small score drop for 12 months.
It’s also important to avoid closing accounts right before you apply for a mortgage or other loan. Even if your lower credit utilization only makes your score drop by a few points, that can really make a huge difference in which interest rates you’re offered by your lender. The cutoff point for the very best rates is typically 740. If your credit score is right on the line, even a minor change can cause you to lose the very best loan terms.
You should also be sure to close all credit accounts on your own terms. That means don’t wait for your bank to close the account because of payment issues. That will hurt your score even more. Also be aware that any customer service representative you speak to will likely try to convince you that another credit product would work better for you. Don’t give them personal details about your reasons for closing the account; simply be firm about your intentions.
You don’t need an expensive credit monitoring service to understand how opening and closing credit cards affects your credit score. You’re now armed with the knowledge you need to strategically manage your credit card accounts to get the best possible scoring in the relevant categories. With a full 35% of your credit score affected by how you use your credit card accounts, there is certainly room for improvement no matter where your number is currently. Before you make any move regarding your credit cards, remember both the long-term and short-term effects those decisions could have on your credit.