by Susan Paige
One of the most oft-cited tropes advising against closing credit card accounts is the potential harm doing so could inflict upon your credit score. And, while that could indeed happen, it isn’t for the reason most people think. With so much uncertainty around the topic, it’s helpful to understand when you should close a credit card account.
Older Accounts and Your Credit Score
The concern most people cite when the subject of closing a credit card account comes up is the potential truncation of your credit history. And, while it’s true 15 percent of your credit score is based upon the length of your credit history, closing an older card won’t make your score drop immediately. After all, a closed account with a positive history will still show on your report for 10 years after the date of closure. Meanwhile, your other accounts will be aging during that time period. Moreover, the Fair Credit Reporting Act requires negative information on your report to drop off after seven years.
The Real Concern
The most significant effect closing an account can have on your score is your credit utilization ratio.
Let’s say you have one credit card with a $5,000 limit and you’ve $1,500 worth of charges on it. This means your credit utilization ratio is 30 percent. That’s generally a good thing, as creditors are happiest when your ratio is 30 percent or less.
Now, let’s say you have two credit cards, both with $5,000 limits and you have $1,500 balances on each of them. With $10,000 in total credit available and a $3,000 balance, you’re still right at 30 percent utilization. However, if you do a balance transfer credit card consolidation in which you move one of those $1,500 balances to the other card and close the account you zero out, your utilization ratio will jump to 60 percent and your credit score will fall.
When Closing an Account Makes Sense Anyway
With all of that said, certain situations outweigh the hit your credit score will take as a result of closing a credit card account. For example, joint cards should be shut down in the event of a separation or a divorce. This prevents one partner from miring the other in a morass of debt out of spite.
Many of us have had that “uh oh” moment when something more expensive than we can comfortably afford catches our eye and proceeds to haunt us for days, weeks or even months afterward. Indulging that desire is simple with a credit card. Online shopping in particular makes it all too easy to punch in your digits and wait by the front door for your new toy to arrive. Closing cards make resisting those impulses easier to do.
Another situation in which closing an account makes sense is to get rid of a card with an exorbitant interest rate or a high annual fee. Maybe you got the account when you were just starting out and qualifying for better terms wasn’t a possibility. You’re getting more favorable offers now that you have a better track record and that card is an albatross hanging around your neck. Kick it to the curb.
Understanding how to decide when to close a credit card account can save you a lot of money. Done the right way, the impact on your credit score can be minimized too. The key is to examine the situation and make your decision based upon facts rather than feelings.