What is the negative impact of cancelling a credit card?

The Hidden Costs of Cancelling a Credit Card: More Than Just Lost Plastic

We all know the allure of decluttering – shedding unused gym memberships, forgotten subscription boxes, and yes, even those dusty credit cards gathering dust in a drawer. But while the act of cancelling a credit card might feel liberating, the repercussions can be far-reaching and surprisingly detrimental to your financial health. It’s not just about losing a convenient form of payment; it’s about potentially undermining years of credit building.

The most significant negative impact of cancelling a credit card is the potential damage to your credit score. This seemingly innocuous action can unravel two crucial components of a strong credit profile: credit history length and credit utilization.

Credit History Length: A Matter of Time

Your credit history is a significant factor in your credit score. Lenders see a long, positive credit history – meaning consistently making on-time payments – as a sign of responsibility. Each year you maintain an active credit account adds to this history. Cancelling a card, especially an older one, abruptly shortens this timeline, potentially lowering your score. This is because the algorithm used to calculate your credit score takes into account the age of your oldest account. Losing a long-standing account diminishes the average age of your accounts, signaling to lenders a shorter track record of responsible credit management, even if your payment history on other cards remains spotless.

Credit Utilization: The Balancing Act

Credit utilization refers to the percentage of your available credit that you’re currently using. Keeping this percentage low – ideally below 30% – is vital for a healthy credit score. Cancelling a card reduces your total available credit, potentially increasing your credit utilization ratio even if your spending remains the same. For example, if you have $1000 in credit card debt spread across two cards with $5000 in total credit, your utilization is 20%. Cancelling one card cuts your available credit in half, instantly doubling your utilization rate to 40%, significantly impacting your score.

Credit Mix: A Lesser-Known Factor

While less impactful than credit history and utilization, cancelling a card can also affect your credit mix. Credit bureaus consider the diversity of your credit accounts, including credit cards, installment loans, and mortgages. A diverse mix demonstrates financial responsibility and expertise in managing different types of credit. Cancelling a card removes an element from this mix, potentially slightly lowering your score, although this impact is usually less pronounced than the effects on credit history and utilization.

When Cancellation Might Be Justified:

Before you rush to cancel, consider the potential drawbacks. However, there are instances where cancelling might be unavoidable or even beneficial. High annual fees for cards you rarely use, cards with unfavourable terms, or cards from institutions you no longer trust are all valid reasons to consider cancellation. However, carefully weigh the pros and cons, and explore alternatives such as downgrading to a no-fee version before completely closing the account.

In conclusion, while cancelling a credit card might seem like a simple act, its impact on your credit score can be significant and long-lasting. Understanding the intricacies of credit scoring and the potential consequences before making a decision is crucial for maintaining a healthy financial profile. Consider the long-term implications before making the cut, and explore alternative options to mitigate negative impacts on your creditworthiness.