27 September 2023

Taking a hit: How cancelling a credit card can harm your credit score

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Tanza Loudenback* says experts say cancelling a credit card can do more harm than good, even if you don’t use it often.

It feels good to get rid of things you don’t use.

It’s why Marie Kondo has become such a sensation, helping people extract the joy from their clutter and toss the rest.

But when it comes to credit cards, it pays to hang on to the old ones, even if they’re collecting dust.

Two important factors in the makeup of your credit score are credit history and credit utilisation, or the percentage of your available credit limit you use each month.

People with excellent credit have more than 20 years of credit history, on average, and keep their utilisation rate under 30 per cent, according to a LendingTree analysis.

If you’re thinking about cancelling a credit card that could affect these factors, you may want to reconsider.

“You should keep old accounts open to boost your credit score, because scoring algorithms look favourably upon long-standing accounts and more available credit,” Ted Rossman, an analyst at Bankrate, said in a recent report.

Bankrate surveyed more than 2,000 Americans about cancelling credit cards and found the top reasons for doing so were having paid off debt, not using the card enough, and a too-high interest rate.

Twelve per cent of respondents even said they cancelled a credit card to improve their credit score.

The degree to which closing a line of credit impacts a person’s credit score depends in part on how many accounts they have open, the size of their balances, and their overall credit limit, Tom Quinn, Vice President of Scores at FICO, told Bankrate.

Importantly, it’s almost never going to give you a positive bump.

The FICO model categorises credit scores as poor (300–579), fair (580–669), good (670–739), very good (740–799), and excellent (800–850).

The three-digit number is an indicator of your trustworthiness as a borrower.

If you have a low credit score, or none at all, buying a house, renting an apartment, taking out a loan, or opening a new credit card won’t come easy.

Quinn said the greatest impact of closing a credit card happens when the credit limit is high.

In other words, you’re better off keeping a credit card that makes up 50 per cent of your total credit limit.

If it’s not offering the best rewards, that’s OK — assign one or two payments to it each month so it remains active and utilise better rewards cards for your other purchases.

There are at least two fine reasons to close a credit card, however, and brave the potential hit to your credit score.

If the temptation to spend is too great or you’re paying a high annual fee for a card you don’t use or gain valuable rewards from, cancelling the card may be the best option.

But keep in mind that it will likely take time and diligence to get your credit score back in good standing after cancelling a credit card, so don’t do it before buying a house or applying for a loan.

* Tanza Loudenback is a senior reporter for Personal Finance Insider at Business Insider. She tweets at @notsoTan_za.

This article first appeared at www.businessinsider.com.au.

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