These days, credit cards make up a pretty big portion of one’s credit portfolio. This is the most common debt, we all carry.
For many, it turns out to be a good form of credit, as it helps in times of emergency, and has the “pay later” option.
Still, for some, it becomes a big obligation, when balances are left uncleared, and penalty charges accumulate over time!
That’s exactly when a certain thought crosses our mind:
“We are better off closing a credit card, than carry its load forever!!”
Here are a few things to know, before you head on to cancel your credit card:
a. First, whether or not this is the only card you have
One section of consumers believes in the idea, that it is always better to carry one card. The reasons, even though debatable, are quite strong.
It helps you to have a good credit portfolio if you can use it responsibly. On time payments and periodical use of a card do ensure a clean credit report. Plus, the perk is, it keeps your credit score intact.
However, on the other hand, many believe (including Mr. Dave Ramsey), that there’s no point in keeping a credit card obligation on your head. It’s a burden they say. One credit card can easily be replaced with a debit card. Especially, if you are using the credit card just to keep the credit account alive!
In such cases of a dilemma, it’s completely upto you, whether or not you want to keep this single credit account open!
If you believe that this account can come of real help in the long run, and you are on the safe side with this account, then it’s better not to remove it from your credit portfrolio!
Else you can get rid of it. But, you got to consider one thing; if you don’t have any other ongoing loan or any form of credit, then closing this credit card will result in a null and void credit profile.
In future, if you want to take out a loan or a credit card, then things will get really difficult, and you will have to build your credit from scratch all over again for approval!
b. Second, if this is a pretty old card, and makes up a good portion of your credit history:
Well now, this is an important factor that you should always keep in mind before you plan to cancel a credit card.
Closing the oldest credit card is probably not a very good idea!
Your credit history is the summation of ages of all of your credit accounts. Closing the oldest account will decrease your average credit accounts’ ages.
As credit history makes up a good percentage of your credit score, it can also hit your credit report pretty badly.
If the card does not have a hefty annual fee or costly charges, then you should not aim to close it! Consider this card to be your base credit account, that will always help you to achieve a good credit score, if used wisely and infrequently!
c. The last thing is, how to close a credit card wisely, so that it doesn’t hurt the credit score:
This part is something, that I feel to be the real trick!
Guess you already know what a credit utilization ratio is. It is your overall credit card debt divided by total available credit limit. The result is then multiplied by 100, to get the percentage.
The hidden art of closing a credit card, without hurting the credit score, is not to increase your utilization ratio!
Well on, here’s the example, to help you understand how to keep the utilization ratio lowered even when you are closing a card.
Suppose you have 3 credit cards:
- CC1: Bal. $2000, Lim. $5000
- CC2: Bal. $500, Lim. $2000
- CC3: Bal $1000, Lim. $3000
Your current credit utilization ratio is : [(2000+500+1000) / (5000+2000+3000)]*100 ; which equals 35%.
Let’s assume that you want to close CC2, as you barely use it.
So, the first thing that you will do, is clear the balance on the card, and then ask the bank to close the account permanently.
Once the account is closed, you are left with CC1 and CC3.
Your new utilization ratio based on these two cards will be, (3000 / 8000)*100, which equals 37.5%.
As you can see, the ratio got increased, which will heavily hurt your credit score!>
Therefore what you need to do before closing a credit card, is that clear all your existing credit card balances!
Once you do that, your utilization ratio won’t increase, and your credit score won’t be affected!
Consider the above example again. If you clear all the credit card balances, then the utilization ratio based on CC1, CC2, and CC3, will be: (0 / 10,000)*100 = 0% (This is ideal and best ratio to have).
Now once you close CC2, your new ratio will still be 0%, as the balances are zero on all the remaining cards!
Hence, keep in mind to clear all your credit card balances before closing a single card, so as not to hurt your credit score.