Can closing your credit cards affect your credit score?
Debbie P. wants to know:
I had a rewards credit card with one of the major airlines for less than a year. However, I just closed it due to the $85 annual fee and a change in the rules about checking luggage. Will canceling the credit card hurt my credit score?
Debbie’s question is a common one. Many people get fed up with credit cards or decide they have too many and decide to cancel them. After they close the cards they find out that closing credit accounts can be bad for your credit score. They start to second-guess themselves and worry that their score will plummet—especially if they’re looking to get a car or home loan in the near future.
Why Are Credit Scores Important?
Let’s take a step back and review why your credit score is important in the first place. Your credit score is a reflection of how you’ve managed bills and debt in the past. It’s like a report card for grown-ups showing how responsible you are with money.
Many different businesses and merchants review your credit report to judge whether they want to do business with you or not. Lenders and credit card companies rely heavily on credit scores as an indication of risk. Having a high credit score means you are expected to be a low credit risk because you’ve demonstrated that you repay your debts.
Having a low credit score indicates that you’re a potentially risky customer who may not repay their debts. Lenders won’t give loans and credit to consumers with poor credit—or they only give them at very high interest rates.
What If You Pay Cash Instead of Credit?
Some people resist the idea that they can be judged so harshly by a 3-digit credit score. They say something like, “I’m never going to borrow any money or use credit cards from those evil banks. I pay cash for everything or I don’t buy it!”
I respect your right to push back from the credit system—but what many people don’t realize is that your credit score is used for much more than borrowing. Having no credit (which is the same as having bad credit) is expensive and may limit your ability to do business with many merchants or to qualify for certain government benefits.
Insurance companies, apartment management companies, utility companies, landlords, and employers are interested in your credit report. If you have a low credit score, you’re likely to get a more expensive quote for auto or homeowner’s insurance. You might be turned down as a tenant or charged a much higher security deposit. Certain employers will review your credit history as a prerequisite for employment. Those are just a few examples of how having poor credit can negatively affect many aspects of your financial life.
What Factors Affect Your Credit Score?
Now that you understand why it’s in your best interest to keep your credit score as high as possible, it’s wise to understand the variables that affect your score. There are many different scoring models; however, here are the 5 major factors that affect your credit score in order of importance:
- Payment history (35%)
- Amounts owed (30%)
- Length of credit history (15%)
- New credit (10%)
- Types of credit (10%)
Is Closing a Credit Card Bad for Your Credit?
Closing a credit card negatively affects 3 out of the above 5 credit factors as follows:
- Amounts owed are the number of accounts you have with balances and the amounts you owe on them. Your “credit utilization” makes up a majority of this credit variable, which is the ratio of your credit balances to your credit limits. Here’s the problem: When you close a credit card you reduce your credit limit to zero, but the balance you owe remains the same. Having more debt relative to your credit limit dings your score.
- Length of credit history is the amount of time that you have information on a credit report. Canceling a credit card account leaves you with less history to demonstrate credit-worthiness, which lowers your score.
- Types of credit is the number and types of accounts you have in your credit report, like credit cards, auto loans, mortgages, home equity lines of credit, and retail accounts. Since having a mix of credit accounts is a boost to your score, canceling all your credit cards reduces your score.
How Much Does Closing a Credit Card Hurt Your Credit Score?
You may be wondering how much closing a credit card can really hurt your credit score. There’s no set amount of points that your score will fall, because everyone’s credit situation is different. Since “amounts owed” make up a large percentage (30%) of your credit score, increasing your credit utilization is potentially the worst hazard to closing a credit account.
That means canceling cards with relatively high credit limits can do the most damage—especially if you’ve had them for many years. So be sure to keep at least one major credit card account in good standing to show that you’re responsible with money. Even if you don’t want to use a credit card for regular purchases, it’s a good idea to make small charges and pay off the bill in full each month. That will build your credit and prevent a card issuer from canceling your account due to inactivity.
How to Check Your Credit for Free
Here is how you can check your credit for free. Staying on top of your credit on a regular basis is very important. Many people have errors on their credit report and getting them cleared up can be a huge boost to your credit score.
To get more tips about how to manage debt and use credit cards wisely, be sure to get a copy of my award-winning book, Money Girl’s Smart Moves to Grow Rich. It’s available as a paperback or e-book at your favorite local or online book store.