Does closing unused credit cards affect credit score?

The Credit Card Closet: When Clearing Out Hurts Your Credit Score

We all have them: credit cards lurking in the back of our wallets, relics of past purchases or signup bonuses, gathering dust and potentially costing us annual fees. The urge to declutter our finances and close these unused cards is understandable. However, before you reach for the scissors, it’s crucial to understand the impact of closing a credit card on your credit score. The truth is, cancelling cards, even those you don’t use, can have unexpected and potentially detrimental consequences.

Often, people assume that inactive accounts are simply inert, neither helping nor hurting their credit standing. This couldn’t be further from the truth. Closing a credit card can trigger a chain reaction that negatively impacts key factors influencing your credit score, primarily:

1. Shrinking Available Credit and Increasing Credit Utilization:

Imagine your total available credit as a water tank. The more water the tank holds, the less impactful any one bucket of water used becomes. Closing a credit card effectively shrinks that tank. This is significant because credit utilization ratio, the amount of credit you’re using compared to your total available credit, is a major component of your credit score.

If you have a $10,000 credit limit spread across multiple cards and you’re carrying a $2,000 balance, your utilization ratio is 20%. Not bad. Now, if you close a card with a $5,000 limit, your total available credit drops to $5,000. Suddenly, that same $2,000 balance represents a 40% utilization ratio, which can significantly lower your credit score. Lenders view higher utilization ratios as a sign of financial instability, indicating that you’re relying heavily on credit.

2. Shortening Credit History:

Credit history is a long game, and the longer you’ve been responsibly managing credit, the better. Closing older credit card accounts, especially those with a positive payment history, effectively shortens your overall credit history. This is because the length of time you’ve had credit accounts open is a factor in credit score calculations.

Think of it as building a financial resume. The longer you demonstrate responsible credit management, the stronger your resume becomes. Closing a long-standing account is like deleting a significant accomplishment from your resume.

When Closing Might Not Be a Problem:

While closing cards often impacts your score negatively, there are instances where it might be less of a concern, or even beneficial in the long run:

• High Annual Fees: If a card carries a hefty annual fee that outweighs any potential benefits, and you’re not actively using the card, closing it may be the right financial decision. Just be sure to consider the impact on your credit utilization and history before proceeding.
• Multiple Cards with Similar Benefits: If you have several cards with overlapping rewards programs and you’re actively using only one or two, closing the redundant ones might have a minimal impact.
• Responsible Credit Management: If you have a long and established credit history, a low credit utilization ratio, and a diverse mix of credit accounts, closing a single unused card might not be a major blow to your score.

The Takeaway:

Closing a credit card should be a carefully considered decision, not a knee-jerk reaction to perceived clutter. Before cancelling any card, evaluate its impact on your overall credit utilization ratio and the length of your credit history. Weigh the potential negative consequences against the benefits, such as avoiding annual fees.

Instead of closing the account, consider keeping the card open and using it sparingly, perhaps for a small recurring purchase you can pay off immediately. This will keep the account active, maintaining your total available credit and preserving your credit history.

Ultimately, a strong credit score is built on responsible credit management, including thoughtful decisions about which credit cards to keep open and which to close. Understanding the nuances of credit scoring empowers you to make informed choices that support your long-term financial health.