Closing a credit card: let’s get the facts straight

There are so many myths surrounding the issue of credit card closing I thought it’d be helpful to dedicate a whole blog post to this topic.
Why should you close a credit card? Well, there are several reasons:

1. The credit card is pure junk, such as one of the worst credit cards in America which are listed here: http://abcnews.go.com/blogs/business/2012/10/6-worst-credit-cards/ – No questions about this.
2. The credit card carries an unsustainable annual fee, such as most loyalty and transferable points cards (if you’re not familiar with reward credit cards, check this post out). Many cards of these types waive the first year’s annual fee, and many consumers don’t find them worth keeping beyond the first year. 
3. You need to apply for big loans and the lender asks you to reduce the amount of credit. A mortgage is a huge amount of money, and creditors are really nervous about giving you the loan while you already have a lot of available debt.
4. You want to apply for more credit cards but already have too much credit available. Usually if your total credit limit exceeds twice your annual income, that would raise a red flag. If your credit limit is below your annual income, you should be safe.
5. You want fewer cards to manage. It is easy to automate credit card management by setting up autopay on all your cards so you never have to worry about missing payments or paying interests. Nonetheless, at some point in life you may find yourself occupied with myriad little things and simply want some peace of mind; 20 credit cards just make you nervous.
6. There may be other reasons that I can’t think of off the top of my head.
7. Totally random reasons, such as the credit card’s looks or the crappy weather.

Suppose you’ve decided that you may want to close a credit card, now how would that affect you?

(You can refresh your memory about credit profile terms by re-visiting this thread:

https://hiepsfinance.wordpress.com/2012/12/02/the-story-from-the-credit-report/ )

In terms of credit score, as long as you leave a $0 balance on the card and do not carry a balance on other cards, the account closure will not have any short-term impact. As you may be aware, I strongly advocate never carrying a balance except in special cases. But suppose that you do, if you close a card, the total credit limit will decrease and the utilization ratio will increase. In that case your credit score will go down. However, if your credit utilization stays under 9% the impact should be minimal.

Another potential concern, credit score-wise, regards the impact on the average age of accounts. Closed accounts are reported to the consumer reporting agencies (CRA’s) for approximately 10 years after closure, and therefore count towards your average age of accounts until they are dropped from your credit profile. After 10 years, you will see a reduction in the average age of accounts, but at that point you won’t have to worry about average age of accounts anyway: anything above 10 years is not going to matter.

Some friends have asked me whether closing credit cards will look bad to future creditors regardless of the credit score. Well, since there are many different reasons one may need to cancel credit cards, it doesn’t matter. The only case where closing credit cards may be looked unfavorably upon is when somebody is a credit card sign-up bonus chaser who closes a new account within one year from opening to avoid the annual fee after reaping the bonus. But then, we as consumers are benefiting from the fierce market share competition between creditors which raises their tolerance level toward attempts to game the system.

From my research, very few people have been blacklisted by creditors for the same reason, and we are talking about people that obtain 30 or more cards per year. I would caution you against closing a credit card too soon, but as long as you keep the card for at least 6 months, or preferably 10 months or longer, you should be fine.

In most cases, you should be fine closing credit cards. But this by no means implies that you should close credit cards. Even though the negative impact on your credit history likely won’t happen until 10 years from now, it will still happen. There are particular cases where it’s usually a bad idea to close credit cards:

1. The credit card in question is your oldest card, since this one card determines the length of your credit history, a very important metric in determining your credit score.
2. The credit card in question has the highest credit limit of all, since it shows your ability to handle large debt.
3. The credit card in question does not carry in annual fee.

If you close a card out of concern about too much credit, you can always ask the creditor to lower the limit, then put the card in your sock drawer and use it once every 6 months to maintain the credit history associated with the card.

The bottom line is, there is very limited negative impact of closing a credit card, unless the card is very old or has the highest credit limit among your portfolio. But don’t close a credit card unless there’s a benefit to doing it.

I hope this post answers most of  your questions about closing credit cards. If you have specific concerns, please address them in the Comments section below. I will respond as soon as I can and update my post with your feedback. Thank you for reading.

Happy President’s Day!

-Richard