What happens if I stop my credit card?

The Double-Edged Sword: What Really Happens When You Cancel Your Credit Card

Thinking about simplifying your life by closing a credit card? It’s a common consideration, especially if you’re trying to get a handle on your finances. But before you reach for the scissors (or the phone), it’s crucial to understand that canceling a credit card can have unintended consequences, particularly when it comes to your credit score.

While it might seem counterintuitive – after all, you’re reducing the potential for debt, right? – closing a credit card can actually hurt your creditworthiness. This boils down to a crucial factor called your credit utilization ratio.

Understanding Credit Utilization

Your credit utilization ratio is the percentage of your total available credit that you’re actively using. It’s calculated by dividing your outstanding credit card balances by your total credit card limits. For example, if you have two credit cards, each with a $5,000 limit, giving you a total of $10,000 available credit, and you have a combined balance of $2,000, your credit utilization ratio is 20% ($2,000 / $10,000 = 0.20).

Credit bureaus generally consider a utilization ratio below 30% to be good, and below 10% to be excellent. Staying within these ranges demonstrates to lenders that you’re responsible with credit and can manage it effectively.

The Problem with Closing Accounts

Here’s where the trouble begins. When you close a credit card, you’re essentially removing that card’s credit limit from your total available credit. Let’s go back to our previous example. Suppose you close one of your $5,000 limit cards. Now, your total available credit is only $5,000. If you still have a $2,000 balance across your remaining cards, your credit utilization ratio skyrockets to 40% ($2,000 / $5,000 = 0.40).

Suddenly, you’ve gone from a healthy 20% utilization to a concerning 40%, all without spending a single extra penny. This higher utilization signals to lenders that you might be more reliant on credit, potentially making you a riskier borrower.

When Closing a Card Might Be Okay

While closing a credit card can often be detrimental, there are some situations where it might not be as impactful or even be the right choice:

• Low or No Balances: If you rarely use the card and it has a very low or zero balance, the impact on your utilization ratio might be minimal.
• High Annual Fees: If the annual fee outweighs the benefits you receive from the card, it might be worth closing, even if it slightly impacts your credit score. You can explore downgrading the card to a fee-free version as an alternative.
• Overspending Temptation: If you find yourself constantly tempted to overspend on a particular card, closing it might be a necessary step to control your finances, even with the credit score implications. In this case, focus on rebuilding your credit responsibly.

Alternatives to Closing a Card

Before you close a credit card, consider these alternatives:

• Negotiate a lower interest rate: Contact your credit card issuer and see if they’ll lower your interest rate.
• Downgrade to a card with no annual fee: This allows you to keep the credit line open and maintain your credit utilization ratio.
• Use the card for a small, recurring purchase: Set up automatic payments to ensure you never miss a payment and keep the account active.

The Bottom Line

Closing a credit card isn’t a decision to be taken lightly. It’s crucial to understand the potential impact on your credit utilization ratio and overall credit score. Weigh the pros and cons carefully, consider alternatives, and make an informed decision that aligns with your financial goals. Remember, responsible credit management is a marathon, not a sprint, and understanding these nuances can make all the difference in achieving financial stability.