February 15, 2021Does Closing a Credit Card Affect Your Credit Score?
Your old credit card. It has plagued your thoughts and haunted your monthly bottom line for years—even decades. That exhilarating moment you FINALLY pay it off gives you such relief that you want to cut the card up and bid the credit card company good riddance forever.
But is this really the best move for your credit score? Starting off with a clean slate might feel good, but sometimes holding on to an “old friend” is better. Let’s dig a little deeper.
Anatomy of a Credit Score
Before we get too deep, it’s wise to explore the anatomy of a credit score and how closing a credit card may affect it.
Your credit score consists of five factors:
- Payment history
- Amount owed
- Length of credit history (how long accounts have been open)
- Credit types (Unsecured vs. Secured)
- New credit
The problem with closing a credit card, which will in some way affect your credit score for better or worse, is not really the impact on score itself. It is with another factor lenders view: credit utilization ratio.
What Is Credit Utilization Ratio and How Does It Affect Your Credit?
The credit utilization ratio is a term that describes how much credit is available to you vs. how much credit you’re using. That means your credit utilization on your recently paid off credit card is 0%. In other words, you use 0% of that available balance. If it’s a high-value card, say $5,000 or more, that might help you improve your credit utilization ratio.
Lenders typically prefer 25% or less utilization. To them, that says you can manage your credit wisely and don’t always push the limits of your available credit.
How Closing a Credit Card Impacts Your Credit Utilization Ratio
Let’s say you have the following balances on credit cards:
- $5,000 spent with a $10,000 credit limit (50% credit utilization score)
- $3,000 spent with a $5,000 credit limit (60% credit utilization score)
- $0 spent with a $3,000 credit limit (0% credit utilization score)
Combined, your total spent would be $8,000 of $18,000 in available credit. Your credit utilization ratio with the recently paid off card would be 44.4% ($8,000 out of $18,000). However, if you close the recently paid off card, the numbers change. Your new credit utilization ratio would be 53.3% ($8,000 out of $15,000), taking you further away from the goal of 25% (what lenders prefer). Closing a credit card with a high limit can cause your credit utilization ratio to rise, and lenders may be reluctant to approve you for more credit.
In most cases, it’s best to forget you’ve got the card but keep the account open. This will help improve your credit utilization ratio. However, if you cannot resist the temptation to spend or have a high annual fee, it might be better to close the account.
We’re Here to Help!
Our goal at the credit union is to help you make the best financial decisions for your unique situation. If you have questions on improving your credit score, stop by any branch location or give us a call at 1-800-226-6673
Each individual’s financial situation is unique, and readers are encouraged to contact PEFCU when seeking financial advice on the products and services discussed. This article is for educational purposes only; It does not constitute legal advice. If such advice or a legal opinion is required, please consult with competent local counsel.