Credit cards can be really helpful when paying for everyday purchases and monthly bills. That is, of course, if you pay your bill in full when it arrives. And although most Americans have closed a credit card at some point in their adult life, most don’t know that it’s a bad idea to do so.
And the reasons for closing a credit card typically aren’t very good. In fact, according to Bankrate.com, 12% of Americans actually think that closing a credit card will help their score as opposed to hurting it. Let’s correct that line of thinking right now.
Closing credit cards negatively impacts your credit
Using credit cards responsibly over time can help you achieve a great credit score. And credit scores hold major sway in our current economic system. Your score can affect everything from mortgage and car loan interest rates to what you pay for your car insurance. That’s right, most insurers use your credit score to help determine the premiums you pay. We’re talking about hundreds of dollars back in your pocket every year thanks to having a solid credit score.
So why would you ever close a credit card? Well, most people don’t realize the negative impacts that closing a card can have. So when they decide they don’t use or want a particular card anymore, they tend to close down that line of credit altogether. Bad idea.
That’s because closing a credit card can have long-lasting effects on your credit score. And particularly if you’ve had that credit card for a long time. You see, closing a credit card negatively impacts a few of the key components that make up your overall credit health.
Exactly how closing a credit card hurts you
One of the major components of your credit score is your credit utilization rate. In normal human speak we’re talking about how much of your available credit you are actually using. The odd thing is that you look like a million bucks to lenders and insurers when you have access to a lot of credit, but don’t actually use much of it. When you close a credit card, you lower the amount of available credit that you have access to. That is not a great idea.
Another important component of your credit score is the length of your credit history. The longer you have accounts in good standing, the higher your credit score goes. If you close a credit card that you’ve had for a while, you are hurting your score by closing that card.
Basically, even if you don’t plan on using a particular piece of plastic that has been relegated to the back of your wallet, don’t take the extra step of cancelling it. In fact, you should actually make a plan to use that card a couple of times a year in order to keep it active in your credit mix. Set a calendar reminder so you don’t forget or just use that card to automatically pay your Netflix bill every month. You don’t want your credit card issuer to cancel that card on you due to inactivity. That will also have negative consequences.
How much will closing a credit card impact my credit score?
The actual drop that you’ll see in your credit score if you close a card will vary from person to person. The numerical drop in score is different because the specifics of our individual credit score makeup are all particular to the individual credit choices we have made. For example, if you close a credit card that you opened just a few months ago that has a minimal credit limit, the impact will be slight.
If you close a card that you’ve had for 15 years that gives you access to a large line of credit, you’ll feel the impact acutely. Your credit score will take a beating for a decision like this.
Closing a credit card when shopping for a mortgage or auto loan only amplifies the mistake. If you are looking to take out a loan in the near future do not, for any reason, close a credit card.
Alternatives to closing a credit card
Hopefully we’ve cleared up the misconception that calling up your bank to close your credit card is a bad idea. Another major reason that people decide to close a credit card account is because they’ve finished paying it off. If you are one of those people, first, let’s celebrate. Woo hoo! And I completely understand the desire to avoid getting back into credit card debt. But two wrongs don’t make a right.
So, instead of closing that card, do what I mentioned above. Hold on to it and use it twice a year. Put it in the back of your sock drawer where you’ll never see it until you get your bi-annual calendar alert. Then go fill up your gas tank or buy a $0.50 banana with that card. Then shove it right back in your sock drawer. Oh, and then pay the tiny bill on time when you get it.
Other reasons that people close credit card accounts are for subpar rewards and high interest rates. Again, those are not great reasons to close a card. They are great reason to a) pay off your card in full every month to avoid paying interest altogether and b) to stop using that crummy rewards card and find a better one.
When is it ok to close a credit card?
So this begs the question, is it ever ok to close a credit card? The answer to this is yes – but it’s a rare situation indeed.
If you absolutely cannot stop using credit cards while there is an account open in your name, then limiting your access is of massive importance. I would recommend freezing your credit card and locking it away in the depths of your icebox. Seriously. Put your card in a Ziploc bag, fill it with water, and toss it in the back of your freezer. That can be a nice preventative step to keep spending at bay. But if that isn’t even enough, closing your account as a behavior modification to prevent yourself from overspending is your best course of action.
Another situation where you might want to consider closing a credit card is if the annual fee is sky high and you don’t tend to use the rewards that the card offers. Make sure to first check with your credit card issuer in order to see if they can move you to another card they offer that doesn’t have an annual fee. That change doesn’t have a negative impact on your score.
Having a few different credit cards can be incredibly helpful for a lot of reasons. Having access to a wide range of credit but utilizing a small amount of that credit is a great way to build a great credit score. Having a few different credit cards in your arsenal is also a great way to maximize the lesser known benefits of credit cards like cell phone insurance, price protection, zero foreign transaction fees, and more.
So if you’ve paid off your credit card balance or you just don’t use it very often, don’t close it! That credit card is often a vital part of your credit score – and having a good credit score has far reaching impacts because of the way the world works today. Just make sure you don’t forget to pay that bill in full every month.