How Closing a Credit Card Can Hurt Credit Scores
When it comes to credit, it’s everyone’s goal to raise their credit score as fast as possible. Have you ever dreamed of achieving a credit score of 800? The reality is, almost everyone has! With that being said, if you are like many other Americans, chances are, you have a few credit cards and think that closing a credit card account after paying it off is a smart decision. While it may seem smart to eliminate any source or temptation of debt, we have some news for you that may shock you. Canceling a credit card account after you pay it off can actually be counter productive and do MORE harm than you may imagine. In this article, we are going to discuss and share how closing a credit card can hurt your credit rather than help it.
The Basics of Credit Cards
To understand our argument, it’s important to have a grasp of the basics of credit cards. First and foremost, the moment you open up a line of credit, your information will be reported to the credit bureaus. This is how you begin to establish a credit history. With that being said, TransUnion, Equifax, and Experian will begin to collect information to create a formal credit report, which will then be used to formulate your credit scores. Your credit profile, or report, will be a direct result of how you handle your personal credit. In light of this, there are five different factors that impact your credit score:
- Credit Payment History (35%)
- Credit Utilization (30%)
- History of Credit (15%)
- New Credit Lines (10%)
- Credit Mix (10%)
How Credit Scores Are Impacted After Closing
Now, with an in-depth understanding of the basics of credit, we can begin to look at how credit scores are impacted after closing an account. So, when you decide to close a credit line, what actually happens is three major factors are impacted:
- Credit Utilization
- History of Credit
- Mix of Credit
With that being said, if you happen to close a credit line that has been opened for a few years, or more, you could do even more damage to your credit score. This is why companies have said that the longer you keep a line open the better. Moreover, when you close off a credit line, say of $5,000, you remove that from your credit utilization. In other words, if you have a total credit line of $10,000 and you close a credit card with an available limit of $5,000, your total available credit line is now only $5,000 in the eyes of the Bureau. As you might have already guessed, such result negatively impacts your credit utilization. A rule of thumb when it comes to credit is that the larger amount of credit available, the better. Utilization accounts for over 30% so be sure to take this into consideration before closing any lines of credit!
The Role of Revolving Credit
If you look at the factors closer, there is one called Credit Mix, or the variety of credit lines you have opened. The Credit Bureaus are referring to automotive loans, student loans, revolving credit, and other installment credits. Now, revolving credit, plays a significant role in your credit score. This is simply known as an open-ended type of credit line, sort-of like a credit card. The best part is that you can use it; however, it’s imperative to pay it on time. In doing so, your credit limit will increase, leading to greater results and credit score increases. Revolving credit is one of the types of credit you don’t want to cancel. These will mature and age, further impacting your credit score in a positive direction. Incorporating revolving credit into your credit profile is typically recommended for your credit mix. The more diverse your credit mix is, the different revolving credit items you have, the better. If you decide to close one of these lines, you can adversely affect your credit score. It’s always smart to evaluate your credit lines before acting and closing one down.
Now, this is gravely different than typical installment credit or loans. These are typically affixed, like a car loan or mortgage. With these, after “x” amount of time, the physical “good” is paid off and then the loan account is closed or canceled. It’s important to understand the difference and types of credit lines before simply canceling one.
What to Do with Old Credit Lines
When many people come to this information, they often ask: “Well, what should I do with these old credit lines?” Most financial gurus will advise credit holders to only cancel only credit lines, only if you are planning on opening new credit lines. However, you should never, ever make this a trend. While canceling a credit line will hurt your credit, opening a new line shortly there after should help in the rebounding process over the next few months.
Now, we would like to mention that there is one major exception to this piece of advice. If you are debating on canceling matured old credit lines, don’t do it. The only lines of credit that should be canceled are young or less mature lines. By avoiding canceling mature credit lines, you can prevent major decreases in your credit score. So, what can you do with those, perhaps you can cast them aside for emergencies!
Take Your Credit Seriously
The best advice that we can give credit holders is to take your credit seriously. Many times, people make the mistake of closing a credit card because they don’t know what else to do with it. As a result, their credit score plummets over the following months, impacting interest rates or eligibility to get a card or new cell-phone. So, before you are quick to make ANY decisions involving your credit lines, it’s essential to do proper research and get knowledgeable. In our opinion, this is your biggest defense and tool to stay in control of your credit score.
Financial Advisor - MoneyBeagle.com
David is our in-house financial advisor with years of experience in the credit card industry. He became interested in credit cards after working for several years at a major bank. He holds a Masters Degree in Finance.