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Canceling a credit card

Your scores will likely take a small hit.

By Karen Datko Oct 26, 2009 3:14AM

This post comes from Jim Wang at partner blog Bargaineering.

Breaking up is hard to do, but canceling a credit card is easy. Call the company, tell them it's just not working out, then cut up the credit card. Easy, right?

What's a little harder? Understanding the impact that can have on your credit history and score.

Why canceling hurts your score

What impact can canceling a credit card have on your credit score? Canceling a credit card will, in a majority of cases, lower your credit score. The primary reason has to do with credit utilization, a significant factor in calculating your credit score.

Credit utilization is a ratio of the amount of debt you have divided by your total credit limit. If you have $500 in consumer debt and a credit limit of $10,000, then your credit utilization is 5%. Remember that consumer debt doesn't necessarily refer to the amount of credit card debt you carry over from month to month. It simply refers to the amount on your statement. So if you charge $500 each month and pay it off in full, your debt amount is still $500 (this is why you don't need to carry debt to improve your score).

When you cancel a card, your total credit limit immediately goes down, which will increase your credit utilization. A variety of other factors can contribute to your score going down, but credit utilization is generally accepted as the biggest reason your score might go down.

Why you should still cancel

The threat of your credit score going down shouldn't stop you from canceling a card if it makes sense to do so. If you've ever been rejected for a line of credit, you know that the potential creditor will mail you a letter with the reasons why you were rejected. In that letter is a list of credit bureau risk reason codes. Several of those codes refer to having "too many" accounts, whether they're revolving accounts, accounts with balances, or other credit-related accounts. If you have "too many" accounts, you may be rejected for credit.

Another good reason for canceling a card is that you never use it and you want to simplify your finances. It's difficult to juggle multiple credit card, bank, broker, and other financial accounts. There's no reason you should try to juggle a card you don't use anymore. Closing the account is one way of simplifying your financial life.

Alternatives to canceling

While I would cancel a card without regard to the credit score impacts, I recognize that it's not the most financially savvy decision. There are alternatives, though.

If you have multiple cards with an issuer, request that the cards be consolidated. Consolidating lines of credit will reduce the number of cards you have but not decrease your credit limit, which means your credit utilization won't increase, leaving your credit score virtually unchanged. Not all issuers offer this but it certainly pays to call to ask. The cards usually have to be of the same type, so you can't consolidate a personal credit card with a business credit card, and they must be from the same issuer, of course.

Can't consolidate? Just stick the credit card in your desk drawer. There's no direct financial harm in not using a credit card. There are two risks with this solution:

  • The card could be stolen. If someone breaks into your home and finds the card, he'll probably take it and try to use it. While it's probably a smaller risk than losing it as a matter of daily use, it's still a risk.
  • The issuer may cancel the card for inactivity. Companies have been canceling inactive and sometimes active cards for the last year as they reduce their risk exposure. If they do cancel it, it has the same effect as if you had canceled it.

Also, you can always cut up the card without calling to cancel. You still run the risk of the issuer canceling the card for inactivity but you don't have to worry about it being stolen. You do have to worry about forgetting you have the card in the first place, which can be mitigated by online account access, if you've set that up.

Finally, the best thing you can do to avoid this is not sign up for a credit card unless you're absolutely certain you need it.

Didn't think canceling a credit card could get this complicated, huh?

Related reading at Bargaineering:

Published Aug. 18, 2009
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