Smart Buying

Think Twice Before You Close a Credit Card

Even if you’re no longer using it, closing an account could ding your credit score.

Paying off high-interest credit card debt is an important step toward financial freedom, and Americans have taken this standard personal finance advice to heart. According to data from the Federal Reserve, revolving credit balances (primarily credit card debt) dropped more than 11% from 2019 to 2020. Analysts believe the decline stems from a combination of spending cutbacks during the pandemic and billions of dollars in stimulus checks, which many consumers used to pay off debt.

If you find yourself with one or more paid-off credit cards taking up wallet space, should you close your accounts for good?

Credit-utilization math. Most experts agree that you should hold on to a paid-off credit card, even if you’re no longer using it. FICO scores, which most lenders use, are calculated based on five factors with varying weights. Your payment history is the most important factor, accounting for 35% of your score, but your credit-utilization ratio—the amount you owe as a percentage of your total available credit—also has a heavy impact on your score, at 30%.

Say you have total available credit of $10,000 split evenly between two cards. One card has a balance of $2,500 and the other has a zero balance because you paid it off. Your credit-utilization ratio is 25%—a desirable amount because most credit experts recommend keeping the ratio under 30%. If you were to close that zero-balance card, though, your ratio would jump to 50%, which would hurt your credit score.

In addition to doing the math with your own accounts before you close a card, you also need to give some thought to why you no longer want the card, says credit expert Beverly Harzog, author of The Debt Escape Plan. Harzog says people most often consider closing a credit card when the rewards aren’t generous enough to justify the annual fee or when they want to remove a temptation to run up more debt. But you may not need to close a card to address those issues.

New card, same issuer. Cards with annual fees often offer rewards—but at a steep price. Such cards will typically cost you about $100 a year, but some can run as high as $550 (see Best Rewards Credit Cards).

If you are reconsidering a card with a high annual fee, ask the issuer if it has a no-fee (or low-fee) card with similar rewards and credit limits you can switch to. If you’re approved, you won’t lose the credit history attached to the old card, and your credit-utilization ratio won’t be affected.

If you can’t find a card to switch to with the same issuer, apply for a new card with a similar credit limit before canceling the old card. That way, your credit score won’t take a prolonged hit, because the amount of your available credit will remain the same.  

If want to remove the temptation to spend, store the card in a safe place where you won’t come across it very often. Or just cut it up. Once you’ve done that, prevent crooks from using it by going to your credit card’s website or app and placing a lock on your account.

“If you truly believe canceling a card is in your best interest, do it, and just ride it out,” Harzog says. The hit to your score will be temporary as long as you continue to keep your card balances low and pay your bills on time.

Rivan_Stinson@kiplinger.com

Most Popular

25 Best Kirkland Products You Should Buy at Costco
Smart Buying

25 Best Kirkland Products You Should Buy at Costco

Many of warehouse club Costco's store-branded Kirkland Signature items get high marks for quality and value. Check out our picks.
July 21, 2021
Warning: You May Have to Pay Back Your Monthly Child Tax Credit Payments
Tax Breaks

Warning: You May Have to Pay Back Your Monthly Child Tax Credit Payments

Unlike stimulus checks, you might have to repay your monthly child tax credit payments if you get too much money from the IRS.
July 16, 2021
Will Monthly Child Tax Credit Payments Lower Your Tax Refund or Raise Your Tax Bill?
Tax Breaks

Will Monthly Child Tax Credit Payments Lower Your Tax Refund or Raise Your Tax Bill?

Everyone loves receiving large sums of money from Uncle Sam. But people who take advance child tax payments may take a hit on next year's tax refund.
July 31, 2021

Recommended

I Inherited an IRA. Now What?
Financial Planning

I Inherited an IRA. Now What?

Here’s what you should consider if you inherit money in either a traditional or a Roth IRA.
August 4, 2021
How Much Umbrella Insurance Do I Need?
umbrella insurance

How Much Umbrella Insurance Do I Need?

Having too much liability insurance is better than having too little. Use our calculator to determine how much umbrella coverage is right for you.
August 3, 2021
How Patients with Lasting Symptoms of COVID Can Apply for Disability
Financial Planning

How Patients with Lasting Symptoms of COVID Can Apply for Disability

Those who can no longer work because of COVID-19 may qualify for these benefits but the approval process can be a difficult road.
July 30, 2021
Long-Term Rates Will Edge Higher
Economic Forecasts

Long-Term Rates Will Edge Higher

Yields on bank savings accounts will stay low. Home mortgage rates will remain affordable.
July 30, 2021