Yes, cancelling a credit card can hurt your credit, particularly if it's an account you've maintained for a long time. The impact often stems from how it affects several key components of your credit score.
How Cancelling a Credit Card Can Affect Your Credit
An account closure can lead to a temporary dip in your credit score by influencing three main factors: your credit utilization, the average age of your accounts, and your credit mix.
1. Increased Credit Utilization Ratio
Your credit utilization ratio is the amount of credit you're using compared to your total available credit. When you close a credit card, you reduce your total available credit. If your outstanding balances on other cards remain the same, your utilization ratio will automatically increase. For example, if you have two cards with a $5,000 limit each (total $10,000 available credit) and carry a $1,000 balance, your utilization is 10%. If you close one card, your total available credit drops to $5,000, and that same $1,000 balance now means a 20% utilization. A higher utilization ratio signals to lenders that you might be relying heavily on credit, which can negatively impact your score.
2. Decreased Average Age of Accounts
The length of your credit history, including the average age of all your open accounts, is a significant factor in credit scoring models. Accounts you've had for many years are considered positive because they demonstrate a long history of responsible credit management. When you close an older credit card, especially one you've had for years, it can reduce the average age of your overall credit accounts. This can make your credit history appear shorter and less established, potentially lowering your score.
3. Altered Credit Mix
Credit scoring models often look favorably upon a diverse mix of credit, such as revolving credit (credit cards) and installment loans (mortgages, auto loans). While closing one credit card usually won't drastically alter your overall credit mix unless it's your only revolving account, it can still have a minor impact by reducing the variety of credit you demonstrate.
When Closing a Credit Card Might Be Less Harmful
While it generally has a negative impact, there are situations where closing a credit card might have minimal effect or even be beneficial in the long run:
- High Annual Fees: If you're paying an annual fee for a card you rarely use, closing it might save you money, and the credit score impact could be outweighed by the financial benefit, especially if you have other strong accounts.
- Irresponsible Spending Habits: If a particular card encourages overspending, closing it could prevent future debt and financial strain.
- Too Many Cards: If you have numerous cards and are looking to simplify your finances, closing a newer card with a low credit limit that isn't frequently used might have less impact than closing an old, established one.
- Fraud Risk: If a card has been compromised or you suspect fraudulent activity, closing it is a necessary protective measure.
Strategies to Mitigate the Impact
If you're considering closing a credit card, here are some strategies to minimize potential damage to your credit score:
- Pay Down Balances: Before closing any card, try to pay down balances on your other credit cards to reduce your overall credit utilization.
- Keep Oldest Accounts Open: Prioritize keeping your oldest credit cards open, even if you don't use them frequently (consider making a small purchase once in a while and paying it off immediately to keep the account active).
- Open a New Account (Carefully): If you plan to close an old card, consider opening a new credit account beforehand to increase your total available credit. However, be cautious with this strategy, as a new credit inquiry can temporarily lower your score.
- Monitor Your Credit: After closing a card, regularly check your credit report and score to understand the impact and identify any unexpected changes.
Ultimately, the decision to close a credit card should be weighed against your specific financial situation and credit goals.
