If you’re thinking of canceling a credit card you have to consider how it will affect your credit score. There are a number of factors that determine the affect it will have, but it’s important to note right away that closing a credit card will never help your credit score. However, it can make managing your credit lines and spending easier to do, putting you in better position to build or maintain a good credit score.
For starters, your FICO credit score is determined like this:
- 35% Payment History
- 30% Amounts Owed
- 15% Length of Credit History
- 10% New Credit
- 10% Types of Credit Used
As you can see, your payment history makes up the majority share of your FICO credit score and stays with you for quite some time. This means that a good payment history will continue to help your credit score, while poor payment history will continue to hinder it, even after you’ve closed the account.
However, the payment history on an account does have a lifespan. Its impact on your credit score lessens over time until it completely falls off your credit report. Negative payment history no longer affect your credit score after the account has been closed for 7 years, while the affects of good payment history lasts 10 years.
The next highest contributor is the amount of credit you have to use and the balances you currently owe. This is known as your utilization rate. To have the best credit score possible, you should keep this rate as low as you can (less than 20%). Let’s use an example to illustrate the utilization rate, and how closing an account can quickly affect it.
Say you have 4 credit cards each with credit lines of $1,000. That’s a total credit line of $4,000. Here are the current balances on each card:
- Card 1: $400
- Card 2: $200
- Card 3: $175
- Card 4: $25
With these current balances, you are using 20% ($800 in total balance) of the $4,000 in available credit. Now, say you decide to pay off the balance on Card 4 and close the account. That leaves you with a total balance of $775. However, because you closed that account, now your line of available credit is at $3,000. That means that you’re now using 25.8% of your available credit, and are now over the 20% benchmark.
You can offset this by asking to raise the credit limit on a card before you close an account, or you can make an extra payment on an account to lower your overall balance. Whatever way you decide to handle it, make sure you know how much money you owe compared to the amount of credit you have available (your utilization rate) before you close an account.
Length of Credit History
When you’re deciding to cancel a credit card, be sure to take into account how long you’ve had that card. If it is you’re oldest held account, then it could have an impact on your credit score.
Say 10 years have passed since you closed your oldest account. Now your credit history has shortened to your next oldest held account. If there is a 10-year difference between these two accounts, then it could have a significant impact on your credit score. However, if there is only a 1 or 2-year difference, then nothing will likely come of it.
If the account you decide to close is not your oldest account, then your length of credit history will not change, and thusly not be taken into account when recalculating your credit score after closing.
New Credit & Types of Credit Used
These two categories make up the lesser portions when factoring in your credit score. The “new credit” factor won’t necessarily apply to you as a person looking to close an account. New credit really only applies to those who are looking to open up new lines of credit. But you may need to pay attention to the “types of credit used” when closing an account.
There are many different kinds of credit accounts: retail accounts, finance company accounts, mortgage loans, and installment loans. Basically what this boils down to is, the more diverse your accounts are, the better your score will be. By canceling an account, you are essentially making your “mix of credit” less diverse. This really won’t impact your score all that much, unless the account you decide to close is your only account.
If the account you close is your only one, and you go 10 years without opening a new one, you’ll be starting back at square one with building your credit score.
Be sure to keep track of all these factors when deciding to cancel a credit card. You don’t want to come out worse than you were before.