Dangers of Canceling Unused Credit Cards
Posted on March 19th, 2009 in Guest Blog
Dangers of Canceling Unused Credit Cards
There’s been quite a bit written about the dangers of credit cards and how if used irresponsibly they can wreak havoc on an individual’s financial well-being. Financial experts agree that if you’re going to use a credit card that you exercise caution. For those struggling with uncontrolled debt, experts have been recommending for years that simply canceling your cards, in particular your unused credit cards, is the best way to go. The reality is that there are both drawbacks as well as benefits when canceling a credit card, but most people are totally unaware of the potential pitfalls when closing these accounts. When closing any credit card account, you have to be mindful of a few things. If you are an individual who has struggled with spiraling credit card debt because of irresponsible use, closing those unused credit card accounts might just seem too obvious. The bottom line is this: if you’re out of control and you do not have enough self- control to stop using the cards, call your card issuer and cancel the account right away. No matter what anyone else tells you about keeping those accounts active, if you can’t stop using them and you continue to pile on more debt, your headed for deeper trouble.
But for those that do not have an out of control credit card debt problem, the dilemma with closing an unused credit card account is that it might actually end up hurting your credit score in a number of different ways. There are several factors that FICO uses to determine your FICO score, which is their proprietary measure of your credit-worthiness:
- Your Payment History (35%)
- Amounts that You Owe (30%)
- Length of Your Credit History (15%)
- New Credit (10%)
- Types of Credit Used (10%)
The “amounts that you owe” accounts for 30% of your FICO score and is a measure of your so-called credit utilization ratio. How can closing an account affect your credit score you might ask? Say, for example, you have two cards, each with $4,000 credit limits for a total of $8,000 in available credit. You have a card balance of $1,500 on one of the cards, giving you approximately 17% credit utilization. If you closed that unused card, your total available credit would drop down to $4,000 total and your credit utilization ratio would suddenly jump up to around 38%. This could drastically affect your credit score in some cases. Admittedly, this will only temporarily affect you so long as you were to pay down that outstanding balance. Nevertheless, it can still affect your credit score negatively.
Also, the “length of your credit history” accounts for 15% of your credit history and closing one of those unused cards with a long credit history can also hurt your credit score.
Here’s the bottom line: as long as you keep your card balances at zero, you can close those unused accounts and you will probably not be affected at all, assuming of course that you do not carry a balance and remain vigilant about keeping those card balances paid off. If you do occasionally carry a card balance, closing one of those unused accounts can drastically affect your credit score, depending on how much of your credit that you’re using at any one time.
There’s at least one situation in which you should avoid closing any of those old accounts though. If you plan on taking out any type of major loan in the next year to 18 months (such as a mortgage or a car loan), you’d be advised not to close any of those old accounts. You don’t want to take a chance on dinging your credit score when it matters the most.
This is a guest contribution from Steve Sildon, Senior Editor for CreditCardAssist.com. Steve contributes frequently to the personal finance blogosphere, providing expertise, tips and advice on a variety of credit-related topics.
Tags: Credit Cards
There’s been a lot of news stories and talk recently about card issuers raising interest rates and telling card holders they can either pay off their cards and close the account(s) or pay the new, higher interest fees.
There’s also been stories about card issuers lowering people’s credit limits. But no one is talking about the real impact of that – for example, my husband and I got our tax refund and decided to pay down our cards since we’re trying to boost our credit scores for an upcoming planned refi. We put a large chunk of the refund money onto one card. Days later, we got a notice in the mail that the card issuer was reducing the card limit all the way down to where we have $66 credit available on that card. That was a tremendous reduction in the credit limit on that card – so significant that it made a big difference on our FICO score because it cut our available credit down by a third and really raised our debt to credit ratio…a few days later, we received another letter from the same card issuer saying that after a routine review of our credit score, our interest rates were being raised! But – if they hadn’t lowered our credit limit as soon as we’d made a big payment, our credit score would have gone UP not down and we wouldn’t have been in the bracket targeted for interest fee hikes.
Needless to say, we feel like we got hit with a double whammy and that in many ways, it feels like deliberate negative manipulation of our credit score on the part of the card issuer. Not to mention, if we’d known this particular card issuer was going to do this, we’d have used the money to pay on some other debt instead!