Why Closing a Credit Card Could Hurt Your Credit Scores

One of the worst credit myths you will come across is the concept that closing old credit cards is good for your credit. Consumers close credit card accounts for a variety of reasons. Some consumers will close an account because they are no longer using it. Another consumer might close his credit card accounts out of fear of running up a large amount of credit card debt. The next consumer might decide to close his credit card account because a promotional rate has expired. However, the truth is that regardless of your reason for doing so, closing credit cards is almost always a very bad idea – one which can potentially take a serious toll on your credit scores.

Why Closing a Credit Card Does Not Hurt Your Credit Scores

Before we address why closing a credit card account could potentially harm your credit scores let’s take a look at another popular credit myth. Credit scoring models like FICO are designed so that consumers with longer credit histories are rewarded with a higher number of points to be added to their credit scores. Because of this fact some financial experts will warn you not to close old credit card accounts because doing so will cause you to lose credit for the age of the accounts. That idea, however, is completely incorrect.

The concept behind this poor advice is the mistaken idea that closing an account could cause your average age of accounts (a factor which is important to FICO) to drop. Yet the truth is that closing an account does not cause the account to disappear from your credit reports. Instead, the account will remain on your reports and credit scoring models do not ignore closed accounts when calculating the average age of your credit. As long as the account is present on your credit reports the age of the account will still be considered. Of course, there is a catch. After 10 years the credit bureaus remove paid, positive accounts from your credit reports as a matter of policy.

Why Closing a Credit Card Actually Hurts Credit Scores

Just because closing a credit card does not cause you to lose credit for the age of the account does not mean that you are in the clear to start canceling your old accounts either. It can still potentially harm your scores when you close an old credit card account due to the impact which this action can have upon your revolving utilization ratio.

We will dive a little deeper in case the phrase “revolving utilization ratio” is new to you. Revolving utilization ratio is a credit term which is used to describe how your credit card limits and your credit card balances relate to one another. Credit scoring models like FICO and VantageScore both pay a lot of attention to how much of your credit limits you utilize on your revolving accounts (aka credit cards). The higher the amount you utilize as it relates to your credit limits the worse the impact will be upon your credit scores.

With FICO credit scoring models specifically your revolving utilization ratios are the primary factors which are considered when calculating 30% of your credit scores. This means that even if you pay every one of your bills on time and follow all of the other rules for having good credit your credit scores could still suffer quite a bit if make a habit of over utilizing your credit card accounts.

Individual revolving utilization is calculated by dividing your credit card balance by your credit card limit (remember to move the decimal over 2 spaces). So, if you have a credit card with a $750 balance and a $1,000 limit your account is 75% utilized (750 ÷ 1000 = .75 or 75%). However, a FICO scoring model does not only pay attention to the revolving utilization ratio on each of your individual accounts. It also pays attention to your total or aggregate revolving utilization ratio as well.

Here is a simple example of how closing a credit card might negatively impact your aggregate revolving utilization ratio.

Aggregate Revolving Utilization with All Accounts Open

  • Credit Card #1: $750 Balance ÷ $1000 Limit = 75% Utilized

  • Credit Card #2: $500 Balance ÷ $500 Limit = 100% Utilized

  • Credit Card #3: $0 Balance ÷ $2000 Limit = 0% Utilized

  • Aggregate Revolving Utilization: $1250 Total Balances ÷ $3500 Total Limits = 36% Utilized

Aggregate Revolving Utilization with Zero Balance Account Closed

  • Credit Card #1: $750 Balance ÷ $1000 Limit = 75% Utilized

  • Credit Card #2: $500 Balance ÷ $500 Limit = 100% Utilized

  • Credit Card #3 Closed – No Longer Factored Into Revolving Utilization

  • Aggregate Revolving Utilization: $1250 Total Balances ÷ $1500 Total Limits = 83% Utilized

As you can see in the example above, closing an unused credit card account significantly raised the aggregate revolving utilization ratio. In this example closing the zero balance credit card account could almost immediately have a very negative impact upon the consumer’s credit scores. This example illustrates the real reason why closing a credit card account might harm your credit scores. As you can see you should be very careful when closing accounts and, honestly, you should only consider doing so if it is absolutely necessary.
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