By ANNA TRINH
If you're like most Americans, you probably have more than one credit card. Having more than one card can give you a higher overall credit limit and a good backup solution if your primary card is stolen, lost or gets declined.
However, while having multiple credit cards can be beneficial, keeping track of all your cards can be tough. Or maybe one of your cards has an expensive annual fee that you no longer want to pay.
You may have heard that closing an account can negatively affect your credit, but even if this is the case, the effect may not be severe.
In certain situations, closing an account can benefit you more than keeping it open. Plus, there are ways to mitigate the effect on your credit score.
When it can be a good idea to close your credit card account
Here are three examples of situations where you may want to close your credit card account.
1. Your credit card's annual fee costs too much. Credit cards with annual fees can be worth keeping if the rewards and perks you get from the card outweigh the fee. But if you're not earning enough rewards to make up for the fee you're paying, it may not be a bad idea to close the account.
Similarly, you might not want to hold on to a credit card just to keep perks such as rental car insurance, personalized travel services or roadside assistance. You may be able to find good perks on some credit cards that don't charge an annual fee.
2. You want to control your spending. If you're trying to manage your spending, closing a credit card could be a good move. For some people, having credit cards makes it difficult to prevent overspending. Closing a credit card account can be a good step to take if your goal is to follow a strict budget. After all, you can't charge on a card you don't have.
3. You have too many cards to keep track of. Having too many cards can make it difficult to keep your finances organized. If you're finding it hard to remember to pay your credit card bills on time, canceling a card may be a good move for you.
Before closing a credit card, you may want to pay off any remaining balance.
A closed account with a remaining balance can be charged off by your lender. This can mean that though your lender may not be expecting you to pay the balance, they'll alert the credit bureaus to the unpaid balance and a negative remark can be added to your credit report, which can lower your score.
Things to consider before canceling a credit card
While closing a credit card may be beneficial to your financial situation, there can be serious drawbacks that you should be aware of before making the cut.
1. Your credit card utilization rate may increase. When you close a credit card account, your credit utilization rate may increase if you don't also pay down your other current balances.
According to Heather Battison, vice president of TransUnion, "If the card you're closing represents a small portion of your available credit, it could have little to no impact on your score. But if the card is a large portion of your available credit, then closing the account may have a negative impact on your score."
This is because closing a credit card decreases your total available credit limit, which could increase your utilization rate.
Let's say that you have two credit cards; one with a $1,000 limit and a second one with a $2,000 limit. Your current balance on your second card is $700. Your total available limit would be $3,000 and your credit card utilization (CCU) would be:
700 ÷ 3,000 = 23 percent
If you close the card with the $1000 limit, you bring your total available limit down to $2000 and your new CCU would be:
700 ÷ 2,000 = 35 percent
This is above the recommended utilization rate of 30 percent or less.
The negative effects of a high utilization rate can be improved once you lower your utilization by paying down other credit card balances or increasing your available credit limit on another card.
2. It can lower your average age of credit history. Closing a credit card account can lower your average age of credit history. This is important because most credit score models value a longer credit history when calculating a credit score.
According to FICO, the age of your credit history makes up 15 percent of your credit score. For VantageScore 3.0, the scoring model that Credit Karma uses, your credit history and types of credit make up 21 percent of your score.
Some scoring models only take your open accounts into consideration, so closing older accounts can potentially cause your age of credit history to take a dive.
So if you choose to close your oldest credit card, this could potentially have a serious effect on your credit. You can use Credit Karma's Credit Score Simulator to estimate the impact this might have on your score.
What you can do if you don't want to close your account
If you want to close one of your credit card accounts but you're worried about the potential impact to your credit score, you should consider talking to your lender - they may be able to help you out with one of the following options.
- Downgrade your card. If your card's annual fee is the main reason you want to cancel, consider contacting your lender and asking if you can downgrade to another card instead; your lender may offer a similar, no-fee version of the card. If this is an option, ask your lender whether your credit limit will remain the same, if your reward points can be moved over and most importantly, whether or not the credit history of the card will also be transferred.
- Ask your lender to change your due date. If you're having a hard time keeping track of your payment due dates, you can contact your lender to change that date for you. You may be able to change all your payment due dates to the same day so that you only have to remember one date every month. This can make it easier to manage your credit card accounts without missing a payment.
Closing a credit card has its benefits and disadvantages. Ultimately, you'll want to decide whether closing a card or keeping it open carries greater benefits for you.
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