How Will The Closure Of A Credit Card Account Impact Credit Scores?
Is canceling a credit card considered unintelligent? Most people aren’t aware that closing a credit card account may impact your credit score. It is, however, necessary to be familiar with the right way to close an account to maintain a healthy credit balance, or your credit score will be compromised.
It is generally recommended that your credit accounts remain open even if they are currently not in use. Continue reading to find out the right way of canceling a credit card when there are valid reasons to close an account.
Credit Utilization Ratio & its Impact
A credit card specialist and consumer finance analyst reportedly said, “Canceling a credit card has the potential to reduce your score.”
Hence, credit professionals do not recommend closing a credit account as it affects the overall credit utilization rate and ratio. This will impact your credit score and pull it down.
The credit utilization rate is your total credit account balance divided by the usage of the available credit limit. As per your credit report, the more available credit you use, your credit score will worsen. Here’s how closing a $0 balance credit account could go wrong:
- Credit card ‘A’ has a $1,000 credit limit and a balance of $1,000
- Credit card ‘B’ has a credit limit of $1,000 and a $0 balance
- The accumulative credit utilization for both cards is 50%
- Closing the credit card ‘B’ account will result in your credit utilization rate jumping to 100%
Aim to pay the full credit card balances each month. A big chunk of money in interest is saved this way, along with protecting your credit scores. Paying the full balance is deemed necessary, especially prior to shutting down a credit account. Your credit score will remain undisturbed if you close an account with a $0 balance on your credit report.
A high utilization ratio can have a negative impact on your credit score. Therefore, it is advised to maintain the utilization rate at 30% or below.
Additional Complications
Along with the potential credit utilization problem, closing a credit account can be taxing for those consumers who don’t have multiple operational credit accounts, as they will be categorized in the “thin” credit bracket. Thin credit makes it difficult to generate a credit score, unlike those who can achieve high scores with more credit tradelines on their reports.
Age of Credit History
Many people believe that shutting a credit account may reduce the age of a credit report. However, this belief remains baseless and unsupported.
FICO and VantageScore scoring models consider elements like the length of credit history and the average age of your credit accounts when calculating your credit report.
The FICO scoring model considers 15% of the length of your credit history. The FICO scoring model uses the average age of closed positive or negative accounts when calculating credit scores, as these accounts stay on your credit report for up to seven or ten years.
The VantageScore model bases 20% of your score on credit. The length of your credit account history is also taken into consideration when calculating your score.
With this scoring model, a few deactivated accounts will not be considered when calculating the average age of your credit. Hence, the closure of a credit account may hurt your score if a lender uses the VantageScore model to make credit score calculations in the future.
Once a closed credit account eventually falls off your credit report, the average age of your accounts may also decrease with the VantageScore and FICO scoring model. You will observe a drop in your credit score due to closing a credit card account – particularly if the account closed was an old one.
Why You May Want To Close A Credit Card
It is not commonly suggested to cancel a credit card but even so, canceling a credit card under certain circumstances could be the most sensible decision.
Failed Marriage
It is advisable to shut down joint credit card accounts after a failed marriage or divorce to avoid immoderate charges on the card out of vengeance or spite. From the lender’s viewpoint, these invoices become a divided responsibility for both parties.
Lofty Yearly Charges
Canceling your credit card is justified when you are charged a high annual fee for an account that is not currently in use. Despite this, if the benefits outweigh the yearly charges for this account, then it may be worth it. The benefits can include travel credits, unlimited discounts and rewards, and other perks.
Contact your bank before closing an account to request the annual charges to be waived off.
To Limit Overspending
While some find it hard to resist using credit cards excessively, there are other means to restrict frivolous spending without harming your credit score.
Keep your credit cards away from yourself and store them in a secure place. The temptation to resist using them would be made easier; their prompt use could be avoided.
How To Shut A Credit Card Account Safely
Follow the steps discussed below to close a credit card account while securing a safe credit score.
- Avail of the unused offers and rewards on your card before canceling it.
- Optimally, all your credit card account balances should be paid off to a $0 balance or close to a minimum when you’re closing any of your accounts.
- Before any closure, double-check with your credit card lender that your balance for that specific account is $0.
- Send an official letter to your bank requesting to close the account at a minimum or zero balance and have the account status mailed to you.
- Follow up on your 3 credit reports after 30-45 days of the credit card cancellation to make sure your requests have been addressed and to ensure that the closure was done by a cardholder.
- Dispute erroneous and negative entries on your credit report with the three major credit bureaus.
Closure Of A Credit Card Account Will Not Affect Credit History
You must have often heard the myth that the closure of a credit card results in “losing credit” for the age of the account.
Former FICO and Equifax credit maestro John Ulzheimer stated that closing a credit card will not instantly remove it from your credit history.
“As long as the credit card remains on your report, you will still get the value of the age of the account in both the FICO and VantageScore branding credit scoring models. The only way to lose the value of the age of the card is if it’s removed from your reports,” said the credit expert.
Closed credit card accounts stay on your credit report for up to seven (in case of negative) or ten years (in case of positive). As long as the closed account shows on your report, it will be used to calculate the average age of your credit.
Additionally, FICO uses 15% of your credit history to calculate your total score. Your payment record and debt amount make up 35% and 30% of the overall credit score, respectively.
How Will Dissolving A Credit Card Affect Credit Score?
Closure of a credit account shifts the credit utilization ratio, harming your credit score in turn. Credit utilization is the calculation of your total credit account balance divided by the usage of the available credit limit. As per your credit report, the more available credit used, the worse your credit score. A 30% credit utilization rate should be aimed for.
Keep Your Utilization Rate Low
Aim to pay a full credit card balance each month as it will save you a big amount of money in interest. As long as all your credit cards show a zero balance on your credit report, your credit account can be closed without your credit score being harmed.
Will Closing An Account Hurt My Credit Age?
Closed credit card accounts stay on your report for up to seven years (in case of negative) or ten years (in case of positive). As long as the closed account shows on your report, it will be used to calculate the average age of your credit.
Takeaway
It is generally recommended that your credit accounts remain running even if they are currently not in use. Credit cards will not always harm your credit score if handled and used responsibly.
Regardless of this, it is necessary to be aware of the correct way of closing a credit card account to maintain a healthy credit balance, minimize damage, and save your credit score from being compromised.
