After paying off a credit card, cancelling it may seem like the next logical step. This is especially true if you see no immediate need for credit, do not want to be tempted to rack up another bill, or have other credit cards with lower interest rates.
These may be sound reasons to cancel a credit card, but before you make the call to do so, you may want to consider the potentially adverse effects that cancelling a credit card can have on your credit score.
Understanding What Affects Your Credit Score
While payment history carries the largest weight in how your credit score is calculated, there are numerous other factors that can influence that score. The length of your credit history, the number of recently opened accounts and credit inquiries, and the number and types of accounts you have are also key credit score factors. The number of accounts you have open and how much you owe on them comparable to your credit limit plays a large role in how your credit score is determined as well.
What Happens to Your Score When You Cancel a Credit Card?
Cancelling a credit card negatively affects three credit factors that determine your credit score.
‘Credit utilization’ is a ratio of what you owe on your credit cards compared to your available credit limits. There is no specific ratio that the credit bureaus recommend aspiring to, but the lower your credit utilization ratio is, the better your credit score tends to be. Therefore, cancelling a credit card and reducing the amount of available credit you have can cause credit utilization to spike, because you will now have a higher debt to available credit ratio. Instead, you are better off paying off and keeping the card, as this will decrease your credit utilization. Keep in mind that it’s preferable to have two credit cards that have low balances than to have one card with a high balance.
Another factor to consider before cancelling a credit card is how long it has been open. Since credit history plays affects your credit score, cancelling a long-standing credit card shortens your history and lowers your score.
If you are considering cancelling the only credit card you have, take into account that credit bureaus (Experian, Equifax, and TransUnion) care about the type of credit you have available. This means that having a mix of personal loans, auto loans, mortgage loans, and credit cards is considered healthy. Cancelling your only credit card will diminish the variety of credit you hold, which can adversely impact your credit score.
It’s important that you consider the pros and cons of cancelling a credit card. Make the decision for yourself after careful evaluation. If you believe that having an extra credit card around will lead you to accumulate unnecessary debt, the benefits of cancelling the card may outweigh the perks of a higher credit score.
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