Does Closing Credit Card Affect Credit Score?
How is credit score impacted by closing a credit card?
A credit score is a major component of your life since it dictates the financial opportunities you get. It includes the interest rates on loans, insurance costs, or even the ability to be granted an apartment. Of course, it is equally important to shield yourself from anything that can cause your credit score to drop. However, what if one chooses to close a credit card account? Will that negatively affect the score? This is what you should know.
How Credit Scores Are Determined?
To better comprehend whether closing a credit card hurts one's score, it is useful to know what makes up a credit score in the first place. FICO and VantageScore are two of the most popular credit scoring systems in use today. While the exact algorithms are proprietary, we know they take into account five main factors.
Credit record How often do you pay your bills? This usually contributes to 35% of the total score you are likely to obtain. Credit utilization ratio The percentage of available credit that is being currently used. Approximately 30% of your final score. Credit age It is the average age of the credit accounts that you have. It can be anywhere between 10-15% of your score. Credit mix This is a category that indicates whether one has credit cards, installment loans, mortgages, or any other type and it contributes to about 10% of the total score. New credit - If you have recently opened any new credit accounts, and how many credit inquiries you have on your credit report. 10% of your score.
As you can observe from the above discussions, several aspects of credit cards are associated with your scores. Therefore, closing an account might certainly change your score. But whether it is beneficial or damaging depends on your credit profile.
The Effects of Closing a Credit Card on the Credit Age
Another key issue that comes into the picture when one closes a credit card is credit age. This refers to the average age of all the open credit accounts you have managed to establish in the market. In most cases, the richer your credit history is, the better it will be.
You should be careful because closing your oldest credit card can significantly decrease your average credit age. For instance, you have credit card A that is 10 years old; however, you decide to close the account. This is because if the next oldest account is less than 4 years, then your credit age will drop from 10 years to 3 years. This could easily subtract as much as 50 or more points from your total score.
The impact also varies depending on the number of credit cards you possess in addition to the card. However, if you manage to pay off the balance and shut down the oldest card but still have several other cards that are almost as old, the impact may not be severe. But if you have only 2 or 3 cards in total, closing one could negatively affect the credit age and your scores.
One way through which this effect can be reduced is by canceling your newest card rather than the oldest card if possible. For instance, if your first credit card is 10 years old but the last one was issued 6 months ago, the 6-month-old card must be canceled. This way, you do not reduce your credit age, something you need to work on when you are in desperate need of credit.
In the following section, the reader will learn how credit utilization is affected.
Age and credit utilization ratio are two factors that are affected when a credit card is closed. This measures the extent to which you are utilizing the credit limit that is available to you. It is advisable to contain this at less than 30 percent.
When a credit card is closed especially if the credit limit on that card is high, it reduces the total amount of credit. As a consequence your credit utilization could increase significantly, provided that you do not change the credit card balances.
For example, let's say you have two credit cards.
Credit Card A has a limit of $5,000 and a balance of $1,000. Credit Card B has a limit of $10,000 and there is no active balance on the card.
Combined, you have $15000 of credit limit and you are currently utilizing $1000 worth. Therefore, your utilization is $1,000/$15,000 = 7%. Great job! However, if you shut down Credit Card B, your available credit is now $5,000 and your utilization rate shoots up to $1,000/$5,000 = 20%. Ouch! While your balances did not decrease, your utilization jumped significantly simply because you lost that available credit cushion.
The short version of getting rid of a card, especially if it has a high limit can harm your credit utilization and credit scores.
New Credit Inquiries as to how they are Affected
The final method of canceling an account that impacts your scores is to fresh credit inquiries. Every time you apply for any kind of credit—including credit card, auto loan, mortgage, and more—the credit provider checks your credit report. Your score can drop if there are too many fresh questions in a short time.
The rub is when you choose to close a certain credit card—especially one you have been using for a long time—then you will probably start to feel the need to apply for another credit card. Many new credit applications lead to fresh questions. Moreover, all those credit checks might lower your scores by 50 points or more if you apply for multiple new cards within a limited period.
Knowledge is Applying for a credit card should be done carefully; one should not apply for a new credit card to substitute a closed credit card account. Any applications should be delayed many months to let the searches vanish from the records.
Measures to Reduce the Effects of Closing an Account
If you have determined it is in your best interest financially to close a credit card, here are some strategies to minimize damage to your credit score.
- Increase credit card payments to reduce utilization first before doing anything else.
- There should be no further applications for credit for 6-12 months after the account has been closed.
- Try to move some of your credit line to another card before that
- It is advisable to close newer cards but never close your oldest credit account.
- Accumulate enough cash reserves so that the frequency of having to use credit after closing an account is reduced.
The Bottom Line
What is the impact of closing a credit card on the credit score? Most of the time, yes but not necessarily. This usually depends on the individual's credit standings and situation. The greatest effect is experienced if by canceling a card, your credit age is reduced, your utilization rate is raised or you have to open several new accounts and thus create many inquiries. Overall, it is important to understand how card closures work and how they relate to your credit. This enables you to make a rational decision about closures of accounts while at the same time making preparations to reduce score harm.
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