How bad is a closed credit card?

The Closed Chapter: How Bad is a Closed Credit Card for Your Credit Score?

Closing a credit card can feel liberating, a symbolic step toward financial freedom. But before you snipe that piece of plastic and gleefully notify the issuer, it’s crucial to understand the potential repercussions on your credit score. The impact, while often not catastrophic, can range from negligible to surprisingly significant depending on your individual credit profile. So, let’s delve into the nitty-gritty and explore just how bad a closed credit card can truly be.

The primary concern revolves around how a closed card affects three key factors that lenders use to assess your creditworthiness: credit utilization ratio, available credit, and average age of accounts.

The Credit Utilization Ratio Conundrum:

Your credit utilization ratio, simply put, is the amount of credit you’re using compared to your total available credit. Ideally, you want to keep this below 30%, and even lower is better. Closing a credit card directly reduces your overall available credit. Imagine you have two cards: one with a $5,000 limit and another with a $2,000 limit, giving you a total of $7,000 available credit. You carry a balance of $1,000. Your credit utilization ratio is around 14% ($1,000/$7,000).

Now, you close the card with the $2,000 limit. Your available credit shrinks to $5,000. With the same $1,000 balance, your credit utilization ratio jumps to 20% ($1,000/$5,000). This increase, while seemingly small, can negatively impact your credit score, especially if you were previously below the 30% threshold.

The Available Credit Avalanche:

Beyond the ratio, having a higher overall available credit can signal responsible financial management to lenders. It shows you’re capable of handling a significant amount of credit without maxing out your cards. Closing a card shrinks this available credit pool, potentially making you appear less creditworthy in the eyes of future lenders.

The Average Age Account Age Albatross:

The length of your credit history plays a role in determining your credit score. Closing a longstanding credit card shortens your average account age. Lenders view a longer, established credit history as a positive indicator of responsible credit behavior. A shorter history, even if spotless, can be seen as riskier. If the card you’re closing is one of your oldest, the impact on your average account age can be more pronounced and potentially lower your score.

So, How Bad is it Really?

The severity of the impact depends on several factors:

• The card’s age: Closing an older card will generally have a greater negative impact than closing a newer one.
• Your overall credit profile: If you have numerous credit accounts and a long history, the impact of closing one card might be minimal. However, if you have a limited credit history, the effect can be more significant.
• The card’s credit limit: Closing a card with a high credit limit will have a larger impact on your credit utilization ratio than closing one with a low limit.
• Your spending habits: If you tend to carry high balances, closing a card can quickly push you above the 30% utilization threshold, resulting in a noticeable drop in your score.

Before You Sever Ties:

Before you close a credit card, consider these alternatives:

• Lower the credit limit: Instead of closing the card, request to lower the credit limit to a more manageable amount. This can help prevent overspending while still preserving your overall available credit and account age.
• Keep it open and use it sparingly: Put a recurring small charge on the card, like a streaming service subscription, and pay it off in full each month. This keeps the account active without encouraging excessive spending.
• Product change: If you’re unhappy with the card’s benefits or fees, consider asking the issuer to switch you to a different card within their product family. This allows you to retain your account history without closing the account entirely.

The Verdict:

Closing a credit card isn’t necessarily a credit score apocalypse, but it’s a decision that requires careful consideration. Understand the potential impact on your credit utilization ratio, available credit, and average account age. Weigh the benefits of closing the card against the potential drawbacks. By taking a proactive approach and exploring alternatives, you can make an informed decision that aligns with your financial goals without sacrificing your creditworthiness. The best approach is to understand your own specific credit situation and consider the long-term implications before severing ties with any credit account.