The careful analysis you need to consider before closing out credit cards
I’m sure most of you have been told that credit cards are bad and they cause nothing but trouble. While this is not completely false, credit cards can provide great benefits if used correctly. For more on how to use credit cards properly, see my article “Credit Card Best Practices”. The purpose of this article is to demonstrate why you should think twice before closing out credit cards that you already own.
This topic was brought to me by a client of mine. He had a card that he owned for years but rarely ever used and it didn’t offer much value. The rewards weren’t that great, the APR was higher than his other cards, and to add icing on the cake the card charged him $39 a year to keep. I know most of you are thinking, “this is a no brainer, close the card and get on with your life…and pocket the $39”. This would be conventional wisdom but let’s take a step back and understand the credit implication that this action would have. This could negatively affect your credit score in 3 ways.
Closing out old credit cards can shorten your length of credit. (15% of your credit score calc!)
As you may know they are 5 factors that contribute to your credit score calculation (payment history, credit utilization, length of credit, type of credit, and new credit opened). By closing a card you can potentially negatively affect this score. In my client’s case this was his oldest card so this would most certainly negatively affect his credit score.
Let’s do the math. If you have 2 cards, one you’ve had for 10 years and the other you’ve had for 1 year. Your average credit history is 5.5 years (10+1) / 2). However, if you close the 10-year-old card your length of credit would now drop to 1 year! You do not want this to happen.
Closing this card can increase your credit utilization (30% of your credit score calc!)
Let’s go straight to the math here. If you have two cards each with $10,000 in available credit ($20,000 total) and you’ve used $5000 on expenditures. You have a 25% credit utilization (rule of thumb is to never go above 30%). Now if you close out one card your credit utilization goes from 25% to 50%! This would severely impact your credit in a negative way.
Closing this card can affect credit mix (10% of credit score calc!)
Credit bureaus like to see a good mix of credit/debt (mortgage, car loan, credit card, etc). If this is your only credit card than this will negatively affect your credit mix. Again we don’t want to do anything to affect our credit score in a negative way.
After this analysis do you still think this decision is a no brainer? Everyone’s situation is different, so I am not saying to never close out credit cards you don’t use but please do a careful analysis. In my client’s situation, this was his oldest card and had the most available credit. So, if he closed this card it would be detrimental to his credit score. As far as the $39 a year, try obtaining a loan with a 600 vs 700 credit score… the difference in interest rate with make that $39 laughable.