Drowning in credit card debt? Have more credit cards than you can handle? Or do you just have a bunch of credit cards you never use?
If you're in any of those situations, at some point, you've probably asked yourself, "should I cancel my credit card?"
Sure, if you just want to stop yourself from using your credit cards, you could just cut them up so they're unusable (except online). But even if you cut them all up, it doesn't erase your debt, and the accounts are still open.
Cancelling your credit card isn’t a choice you can make so lightly.
Just because you don’t intend to use your credit card anymore doesn’t mean the it’s such a good idea to cancel it. So how do you know whether you should cancel a credit card or just keep it?
The effect of canceling your credit card
Cancelling your credit card card can drastically affect your credit score, mostly affecting three different areas:
Credit card utilization ratio
Credit utilization ratio refers to the balance on your credit card measured against the maximum available to you at any given time.
This number is calculated with all your credit cards in mind. For example, say you have $500 in credit from three different card providers. In total, you have a limit of $1,500. If you have a balance of $250 each on two of those cards, you have a ratio of 33.33% ($500 to $1,500).
If you decide you’ve used enough from those credit cards and decide to cancel one of them, your ratio will increase to 50%.
This will be a problem because the way your risk is calculated, the lower the credit card utilization, the better. In other words, that means you only put to use a small amount of the money that has been loaned to you.
Most of the time, a credit card utilization that’s lower than 30% indicates you know how to handle credit, and possibly yourself. Ideally, a number less than 10% is the best to maintain for your credit score. If you happen to be in the 40%+ range, you’re in the grey or maybe red area.
Average age of accounts
Average Age of Accounts is one of the most important factors that contributes to the Length of Credit History aspect, which accounts for up to 15% of your FICO score.
As the name suggests, this metric is calculated as anyone would imagine. That is, the age of all your credit accounts is added then divided by the total number of accounts your own.
Keep in mind, however, that when you close one of your accounts, it will stay on your credit report and still age for ten more years. In other words, if you decide to open a credit card today and cancel it the next day, it will still show up in your credit card report and contribute to your history in nine year’s time.
The model is intrinsically flawed, but you can use it to your advantage.
If you had three credit cards which are aged 4, 3 and 2 years respectively, the average age of your accounts is 3 years. If you cancel card 2, your accounts will be 14, 13 and 12 years in ten years respectively.
Basically, the average age of your accounts doesn’t change despite you cancelling card 2. However, this remains only for ten years. Once it drops off your account, your average age of accounts will go down.
Number of accounts
The total number of credit card accounts that you have at any time also impacts your credit score.
Cancelling your credit card is the most effective way of getting this number to go down lower. An excessive amount of debt is one of the indicators that you should consider closing some of those cards.
However, it’s not all black and white: since a cancelled account remains on your history for around ten years, it may be that long before you notice any change.
If you have several accounts with a zero balance, it's probably not worth canceling them.
When should you cancel your credit card?
Depending on which card you close, it could have a negative impact on your credit score. Could there really be a motivation strong enough to warrant closing a credit card account?
Definitely, yes. In some circumstances, there is no other viable option other than closing your credit card account.
In some instances, you are better off canceling your credit card rather than keeping it open. Some circumstances that may force you to shut it down include:
You have a debt problem that you cannot control
The most understandable reason for canceling a credit card is because you have trouble paying the money you owe at the end of every month.
Getting out of debt should be one of your biggest priorities, in order to achieve both financial stability and solidify your credit score. If you’re struggling in debt to begin with, your credit score is likely already in trouble, anyway.
Despite the fact that cancelling your credit card might make this worse, it will at least stop the bleeding if you just can't seem to stop spending.
Alternatively, you could keep the credit card open and slowly pay it off, as long as you don’t use it. In most cases, the latter option is the best way to go about it.
You have high interest rates and are paying a bunch of fees
Annual fees are the most common credit card fees. The annual fee is automatically charged once every year on your credit card for extra benefits that come with the credit card.
Depending on the credit card, these fees can start as low as $25 and run up into hundreds of dollars or more. The more benefits the card offers, the higher the annual fee. These include reward credit cards, secured credit cards and premium credit cards.
Not all credit cards charge an annual fee, however.
Most credit card issuers that charge this fee usually waive it during the first year of use. After that, the fee is charged to your account automatically every following year, and you might not even notice it.
If you decide paying annual fees isn’t worth it after the first year, you can close it. Afterwards, you’re free to apply for a card from the same issuer that doesn’t have any annual fees.
Summary
Since cancelling a credit card will negatively affect your credit score, you should think the decision through carefully.
Weigh the pros and cons of your decision and come to a conclusion that doesn’t have any high implications on yourself. If you’re just out to raise your credit score by a few points, you’re better off leaving your credit cards alone and paying the debt away slowly.
However, this doesn’t suggest cancelling your credit cards is always a bad idea.
If you’re paying unnecessary fees every year, that’s one of the signs you need to close that account.
If you don’t have enough self control and keep shooting your debt through the roof every month, that’s another great sign.
If you can’t keep your credit in check, you should either close your account or simply stop using the credit card altogether.
By default, the best way to approach the issue is to only have a few credit cards to begin with.
More importantly, don’t put too much money on your credit cards. This way, both your credit-to-debt and credit utilization ratio are good. You won’t have to deal with revolving debt and don’t have anything on the side draining your income.
When you’re financially stable and in good shape in the same regards, it then makes sense to cancel cards you no longer need.
