Why You Shouldn't Close Unused Credit Card Accounts
As a young adult, you've probably heard that you should keep your credit card accounts open, even if you're not using them. But should you really? If an unused credit card account is closed, does it matter? In this piece, we'll discuss why you shouldn't close unused credit card accounts and how doing so can hurt your credit score.
Key Takeaway:
Closing your credit card accounts can negatively impact your credit score, primarily due to the reduction in your credit utilization.
Although closing an unused credit card account is typically not a good idea, there are some circumstances in which it might be the right thing to do.
Before closing a credit card account, you should assess your situation to determine if closing them would be right.
Why You Should Avoid Closing Credit Card Accounts
Closing your credit card accounts can negatively impact your credit score, primarily due to the reduction in your credit utilization. Even if they are rarely used, it is beneficial to keep credit cards open, as this helps maintain a positive payment history and a longer credit account age.
Understanding Your Credit Score
Your credit score is a three-digit number that lenders use to decide if you are creditworthy. It is based on several things, like your payment history, credit utilization ratio, length of credit history, mix of credit, and new credit.
Your credit utilization ratio is an important part of your credit score. This is how much credit you're using compared to how much credit you have. If you have a $10,000 credit limit and use $5,000 of it, your credit utilization ratio is 50%. A high credit utilization ratio can hurt your credit score, while a low credit utilization ratio can help your score.
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How Your Credit Score is Calculated
Your credit score, also called your FICO Score, is a very important number that lenders use to figure out if they should give you credit. But how is it exactly worked out? Well, it's kind of like putting a puzzle together. FICO Scores use different parts of your credit report, which is like a snapshot of your financial past, to figure out your score. There are five groups of puzzle pieces, and each one counts for a different amount toward your score. Your credit score is calculated according to the following:
35% payment history- This tells lenders if you've paid your bills late or on time.
30% amounts owed- Amounts owed or outstanding balances make up this portion.
15% length of credit history- The longer you've had credit, the more information lenders know about how you handle your money.
10% new credit- This includes newly opened accounts or credit inquiries.
10% credit mix- This is made up of the types of credit you have, such as credit cards, loans, or a mortgage.
So, remember that building a good credit score means putting these puzzle pieces together in a careful and responsible way.
What Happens When You Close Credit Card Accounts You Don't Use
When you close a credit card account, you reduce the total amount of credit history you have. This can negatively impact your credit utilization ratio, resulting in a lower credit score.
For example, you have two credit cards with a total credit limit of $10,000. The balance on one card is $2,000, while the amount on the other card is $0. As a result, your credit utilization ratio is 20% overall. If you closed the card with no debt, your total available credit would go down to $5,000, and your credit utilization ratio would increase to 40%. On your credit score, this could have a negative impact.
Here's the calculation for the initial scenario:
Total credit limit: $10,000
Balance on one card: $2,000
Balance on the other card: $0
Total credit card balances: $2,000 + $0 = $2,000
Credit utilization ratio: ($2,000 / $10,000) * 100 = 20%
Now, let's calculate the credit utilization ratio if you were to close the card with no debt:
Total available credit after closing one card: $10,000 - $5,000 = $5,000
Credit utilization ratio: ($2,000 / $5,000) * 100 = 40%
Another thing to think about is how long you've had credit. How long you've had open credit cards is a big part of figuring out your credit score. When you close an unused credit card account, you shorten the length of your credit history, which can negatively affect your credit score.
A negative impact on your credit mix can also result from closing an unused credit card account. Your credit mix includes your credit cards, auto loans, and student loans, among other types of credit. Your credit score can increase if you have various credit cards. When you close an unused credit card account, you make your credit mix less varied, which can hurt your credit score.
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When Is It a Good Idea to Cancel a Credit Card Account?
Although closing an unused credit card account is typically not a good idea, there are some circumstances in which it might be the right thing to do.
High Annual Fees- If the credit card has a high annual fee and you don't use it, it may be worth closing the account to avoid the fee. Also, if the credit card has a high-interest rate and you don't use it, it may be better to close the account and focus on paying off any other debt you have.
Divorce or Separation- Joint account holders will be held liable for all past or future charges should you have to go through a separation or divorce.
Temptation- If you find that you aren´t responsible enough to not swipe your credit card and pay at least the minimum balance each month then it would be a good idea to cancel it.
It's important to know that stopping a credit card account won't necessarily get it off your credit report. Depending on the credit bureau, closed accounts can stay on your credit record for up to 10 years after you close them. But closed accounts that had no balance and were in good standing when they were closed won't hurt your credit score very much.
How to Close a Credit Card Account Correctly
If you decide to close a credit card account, you can do a few things to keep the negative impact on your credit score as low as possible. One choice is to ask your credit card issuer for a product change. This means that instead of closing the account, you can switch to a different credit card product from the same provider. This will keep the account open and current, but you may need to meet some eligibility requirements for the new product.
Another choice is paying off any outstanding balances on the card before closing the account. This will ensure that you don't still owe money on the account and will have the least effect on your credit utilization ratio.
If you decide to close a credit card account, keep an eye on your credit score and report to ensure there are no mistakes or discrepancies. You can request a free credit report from each of the three major credit bureaus once a year, and you can use online credit tracking services to keep track of changes to your credit score.
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Money Takeaway
Before closing a credit card account, you should assess your situation to determine if closing them would be right. Remember that your credit score is a big part of your ability to get loans, credit cards, and mortgages and that a good credit profile can help you reach your financial goals and become financially independent. Stay informed about your credit and financial health by joining our email list today!
