When you make an effort to pay off a large amount of credit card debt, it can feel good to be able to cancel your credit card accounts and be out of debt completely. While this is a common practice among people who are paying off debt, it may not always be the best decision that you could make financially. In some cases, canceling your credit card could hurt you in other ways that you did not foresee.
Credit Utilization Ratio
During the process of figuring out your credit score, credit bureaus look at a metric known as the credit utilization ratio to help calculate your credit score. The ratio aims to compare the amount that you owe on your accounts to the total credit that you have. When the two numbers get somewhat close together, this will negatively affect your credit score.
Credit bureaus like to see that you keep your total debt down below about 30 percent of the available credit. If your debt is below this number, your credit score will be positively impacted. If your debt goes up above this number, your score will go down.
Canceling a credit card account could end up damaging your credit score. If you cancel a credit card, it lowers the amount of available credit that you have to your name. If you still have debt on another account, your credit utilization ratio will jump up dramatically.
For example, let’s say that you have two credit cards with $10,000 credit limits and one of the cards has a $4,000 balance. Currently, you have a 20 percent credit utilization ratio, which is pretty good. If you cancel the card that doesn’t have any balance on it, you’re left with $4,000 of debt compared to $10,000 of available credit. This changes your credit utilization ratio to 40 percent, which is viewed as negative by the credit bureaus. By simply canceling one of your credit cards, you have negatively affected your credit score.
Length of Credit History
Canceling your credit card can also negatively affect you in other ways. The credit bureaus also look at the link of your credit history when determining what your credit score should be. They like to see long histories with the same creditors. For example, having the same credit card for 15 years would be viewed as a positive by the credit bureaus. If you happen to cancel the card that you have had the longest, you will negatively affect your credit score. If you cancel one of the cards that you have not had that long, it shouldn’t have much of an impact on your score unless the ratio has been affected.
While canceling a credit card can negatively affect your credit score in a few different ways, it may be a wise move if you are having trouble avoiding the temptation that comes with your card. If you regularly use your credit card to make purchases that you can’t afford to pay for, this can really hurt your financial situation. Once you build up some debt on your credit card, the credit card companies will make quite a bit of money off of you in interest charges. If you are always paying interest to the credit card companies, it can be very difficult to get ahead financially.
In this situation, it can make sense to cancel your credit card even though it may do a little bit of damage to your credit score. You will be in much worse shape if you can’t avoid accumulating large amounts of credit card debt.
Father of three and married to a lovely women. Always looking for ways to save money, and invest it properly for my children's future.