Why does Closing a Credit Card Could Hurt Your Credit Scores
Table of Contents
Introduction
A credit score is a primary factor for loan applicants. People with good credit scores will enjoy the benefits of loan application processes to the fullest extent because they make all possible attempts to improve their credit scores. Closing a credit card is one of the methods to improve a credit score, and this article examines the option of closing the credit card accounts, and its benefits and drawbacks.
Closing the Credit Card Account
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 will 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 that 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. To make use of the effective services of TheCreditPros, contact us.
Why Closing a Credit Card 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 will still potentially harm your scores when you close an old credit card account due to the impact this action will have on your revolving utilization ratio.
We will dive a little deeper in case the phrase “revolving utilization ratio” is new to you. The revolving utilization ratio is a credit term that 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 that 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 of making a habit of overutilizing 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 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 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 on 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 necessary.
Frequently Asked Questions
Will closing credit cards increase credit score?
Closing a credit card will not affect your credit score. If you’re closing an old or unused card, you’re removing your available credit.
Is it bad to get a credit card and not use it?
If you’re not using your credit card for a long time, the card issuer may eventually close the credit card. This will lower the age of the credit card history, as a result, the credit score may also come down.
What are the disadvantages of closing a credit card?
The credit of the account disappears, and the average period of the credit lowers, which may affect the credit score, but that is not a significant loss.
What are the ways to close a credit card?
It is best to not close a credit card for the sake of increasing credit scores, but if using credit cards pulls their users into debt, then they may choose to close their account by contacting customer support either online or through a branch location.
What are the things to consider when using a credit card?
- Focus on the capacity to pay your bills.
- Check the bills do not exceed the available balance.
- Make sure the interest ratio is affordable.
Conclusion
People may have multiple opinions on closing a credit card and its effect on the credit score. You should understand that closing a credit card is not going to guarantee an increase in your credit score, so it is moot to close your credit card to increase your creditworthiness. Instead, closing the credit card account will help you balance your loan and credit scores, especially if you don’t feel you are not responsible when using the card. Closing the credit card account lowers your credit score to a smaller extent as it may affect the credit utilization ratio, but you need not fear that closing a card will hurt your credit score. Teaching the students about credit building is one necessary thing to give students financial exposure.
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