Does Closing Your Credit Card Hurt Your Credit Score?
You did it! You paid your final credit card payment and closed the account to be done with it once and for all.
But then your credit score went down.
You were told getting rid of such debt was a good thing - so why did your score take a dive? While getting rid of your credit card debt is great for your credit score, getting rid of your credit card account might not be as beneficial.
Why Is Credit Score Important?
Before you start worrying about how much closing a credit card can hurt your credit score, it's important to know what a credit score is and why it's important. In short, a credit score is almost like a financial report card that tells lenders how well you can handle credit. It helps them determine whether to lend you money, how much to lend and with what terms.
The higher your score, the more likely you'll get approved for a loan and the more favorable your terms will be. Keep in mind, credit score requirements are different for each type of loan or line of credit. For example, the credit score requirement for a personal loan may be different from what's required for a mortgage or car loan.
How Does Closing A Credit Card Affect Credit Score?
According to the Fair Isaac Corporation, responsible for the industry-standard FICO® Score, five factors determine credit score:
Payment History (35%)
Amounts Owed/Credit Utilization (30%)
Credit History (15%)
New Credit (10%)
Credit Mix (10%)
When you close a credit card account, it can have a negative impact on many of the factors listed above. Let's take a look at how each will be affected.
If you have a good history of on-time payments on this account, that will no longer show up once the account is closed. Keeping the account open will help show future lenders that you're a responsible borrower with a long history of making payments on time.
Amounts Owed/Credit Utilization
When you remove a credit account, you remove that amount of credit available to you. When your total available credit, or total credit limit, goes down, your credit utilization rate may go up.
Credit utilization rate, also called your credit utilization ratio, is the amount of credit you're using divided by your credit limit. The lower your credit limit, the harder it may be to keep your credit utilization low - especially under the recommended 30%.
Here's an example. Let's say you have four credit cards, with balances on each one.
- Credit Card #1: $5,000 credit limit with a balance of $1,000 owed
- Credit Card #2: $10,000 credit limit with a balance of $1,000 owed
- Credit Card #3: $2,500 credit limit with a balance of $2,000 owed
- Credit Card #4: $8,500 credit limit with a balance of $3,500 owed
Your total credit limit from all four cards is $26,000. The total amount of credit you're using is $7,500. To get your rate, you divide $7,500 by $26,000 with equals about 28%, which is considered good.
If you pay off Credit Card #1 and keep the account open, your total credit limit would stay the same ($26,000) and the total amount of credit you're using would drop to $6,500. Thus, your new credit utilization rate would be 25%.
However, if you pay off the card and then close the account, you would lose the $5,000 credit limit that goes with it. That means, your new total credit limit would be $21,000. Now, with the account closed, your new utilization rate would be about 31%, which is considered average.
By closing the account, you'll have a higher rate than you had before you paid off your $1,000 balance.
When it comes to the length of your credit history, or age of credit, the average age of your accounts together is the one that matters. When you close credit cards and other loans and they no longer appear on your credit report, these accounts are no longer included in that calculation. That makes it especially harmful to your score if you close your oldest account.
Here's an example. Let's say you have:
- A car loan - 4 years
- A mortgage - 3 years
- A student loan - 9 years
- A basic credit card - 14 years
- A rewards card - 7 years
- A store card - 5 years
The average age of your accounts is 7 years, which is considered good. Let's say you closed your oldest account, which has been open for 14 years. Your average age of credit after closing that account would be 5.6 years, which is considered average.
When reviewing your credit history, credit card companies and lenders like to see a mix of credit. It shows that you're capable of handling different types of debt. A good credit mix will have some revolving credit, like a credit card and some installment credit, like a mortgage or personal loan.
Closing any account can mess with your credit mix. This can be especially detrimental to your credit profile if you don't have many accounts and it is the only one like it in your mix.
When Should You Close A Credit Card Account?
While it's recommended you keep your accounts open if you can, there are some instances where it may make more sense to close an account.
- You're going through a divorce and your soon-to-be ex-spouse is a cardholder on the account.
- You can't control your spending and you keep racking up credit debt.
- The credit card has high annual fees that outweigh its benefits.
- The credit card has an extremely high interest rate.
- If it's a relatively new card and has a low credit limit, so closing it won't impact your credit history or utilization by much.
Alternatives To Closing An Account
To help you keep the account open and get the most out of it, try these alternatives:
- Call your card issuer and ask to change the card to one that better suits your goals and is from the same issuer.
- Call your card issuer and ask for a lower interest rate or to waive the card's annual fee.
How To Increase Your Score After Closing An Account
If you've already closed an account, don't fret. Many of these negative hits are temporary, so be patient. There are also steps you can take to improve your credit score while you wait.
Increase Your Credit Limits
One way to decrease your credit utilization rate is to get more available credit. That doesn't mean you should go out and get a new credit card - that could also lower your credit score. Instead, try increasing the credit limit on the cards you already have.
All you need to do is call your credit card issuer and request a limit increase. If you've been making on-time payments for a while, have had the credit card for a good amount of time and aren't asking for an extravagant increase, the credit card company will be more willing to oblige.
Pay Down Your Debts
Another way to decrease your credit utilization is by lowering the amount of credit you're using. That means, paying down your balances owed.
Review your credit card balances and other loans and determine the best way to pay off your debt. Two popular methods are the debt snowball and the debt avalanche. The debt snowball recommends paying off your debts from the lowest balance to highest, while the debt avalanche recommends paying debts from highest interest rate to lowest.
Keep Your Credit Card Accounts Active
Continue to use the card by putting only small amounts on the card and paying them off right away. One way to do this is to set up auto-pay for a small monthly bill (like a subscription). Just remember to pay it off every month.
This is a great strategy to start using any old credit cards or unused credit cards you have. If you go too long without using your card, the credit card company may close the account on you.
While you can avoid lowering the average age of your accounts, you can't do anything to increase it except wait for it to happen naturally. Just keep making payments to your accounts, avoid finance mistakes, keep your utilization low and keep your accounts open to allow your credit history to age and expand gracefully.
Another thing that will come with waiting? Negative marks will be removed from your report after a certain number of years. For example, missed payments and bankruptcies typically stay on your report for 7 years while hard inquiries stay on your report for 2 years. Once these blemishes are removed, your score will go up.
Review Your Credit Report And Credit Score
You should review your credit report once per year to identify any fraud, identity theft or clerical errors and have them fixed right away. You can receive a free credit report from each of the three credit bureaus – TransUnion®, Equifax™ and Experian® - annually. You can also check your score from our sister company RocketHQSM, which updates your score every 7 days.
You should be checking this regularly to better understand your credit standing and where you can increase your score. This can help put you in a better position to get accepted for a loan and receive better rates.
A low credit score can make it harder to qualify for credit cards and other loans. And even if you do qualify, you'll likely have tougher terms, like high interest rates. While paying off your debt will help increase your score, closing the accounts can actually hurt it.
The best thing to do is continue making payments on time, keeping your utilization low and keeping your accounts open so you can maintain a healthy and long credit history. All of this will reflect that you're a responsible borrower and a great candidate for additional credit.
As with all decisions relating to personal finance, we also recommend speaking to your financial advisor, who can recommend the best option based on your personalized goals.
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