Should You Break Up With Your Credit Card?
Closing a credit card account you have paid off or don't use seems like a logical thing to do. But the "credit utilization ratio" is one of the major factors in calculating your credit score, accounting for approximately 30% of it, and closing an account can have a dramatic effect on that ratio.
|Closing a credit card account you have paid off or don't use seems logical. But watch out for how cutting up that card affects your "credit utilization ratio."|
When it comes to your credit cards , the credit utilization is the ratio of all your credit card balances to the credit limits available on your cards. Having a low ratio -- not having much debt but a lot of available credit -- is beneficial to your credit score, while a high ratio may indicate you may be a risk for default. A healthy credit utilization ratio is anything below 30%.
Closing an old or unused card erases some of your available credit and increases your credit utilization ratio. For example, say you have two credit cards -- one with a $3,000 balance and one with no balance, and each card has a $5,000 credit limit. Your credit utilization ratio is 30% ($3,000 divided by $10,000), a very attractive ratio for lenders to see. But if you close the account with no balance, you decrease your available credit by $5,000, so your credit utilization ratio increases to 60% ($3,000 divided by $5,000).
Another major factor in calculating your credit score is the length of time you've had credit. If you have to close a credit card account and you are choosing between two equal cards, close the one with the shorter history. It is usually better to keep your credit card accounts open for a long time.
Here are some considerations on whether to cancel a credit card account:
- Look at your total available credit. Add up how much available credit you have and how much credit you are using. Your goal should be to keep your credit utilization ratio below 30%. If you have few credit cards, or a high credit utilization ratio, keep the account open. If you have several credit card accounts with large credit lines and you pay them off each month, you should see a minimal effect from closing a credit card .
- What is your credit score? If your credit score is excellent, losing a few points won't be a big deal. If you are building or repairing your credit score, leave the account open.
- Does unused credit tempt you to overspend? If these temptations have historically gotten in the way of sound financial judgment, it is better for you to close an account even if it does slightly lower your credit score. Running up needless debt is one of the worst financial mistakes you can make.
- Will you be applying for a loan in the near future? If you have a good credit score and no plans to apply for a loan, close the account. If you are about to buy a house or a car, keep your credit accounts open until you have been approved for the loan.