Whether you have too many and want to cut back, or you want to limit your chances of overspending, we’ve probably all found ourselves in the situation of trying to decide whether or not we should cancel a credit card. Before jumping the gun, you should first consider how doing so could affect your credit score – because it will, and not in a positive way.
Why your credit score matters
In case you’re not familiar with credit scores, it’s a number that’s assigned to you by the credit-reporting agencies in Canada (Equifax and TransUnion) that falls between 300 – 900. The higher your number, the more creditworthy you are. This matters because if you ever plan on getting a loan in the future e.g for a car or home purchase, lenders will want to know how responsible you are at paying back your loan. Generally speaking, if your score is 600+ you’ll be in good standing, but every lender has different criteria when approving loans and your credit score is just one part of that process.
How your credit score is calculated
Let’s review how your credit score is calculated. Remember that “credit” is a tool you can use to pay for something without physically having the cash in your wallet, on the promise that you will repay it. Typical forms of credit include: credit cards, lines of credit, mortgages, student loans, etc. How you use your credit is ultimately what determines your credit score and is calculated based on the following criteria:
- Payment history
- Use of available credit
- Length of credit history
- Types of credit
- Number of inquiries
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How cancelling a credit card hurts your credit score
If you are considering cancelling a credit card (closing the account), there are two ways this action could affect your credit history and credit score. First, if it is your oldest card, closing the account will affect the length of your credit history. However, even after you cancel a credit card, the account will still show on your credit history for around 7 years. As a result, cancelling your oldest credit card account would not have an immediate effect on the length of your credit history. The effect it would have down the line, however, would depend on how old your other credit cards are.
For example, if you cancel one credit card that is 10 years old and leave open a credit card that is 2 years old, then after 7 years when the card you cancelled is removed from your credit history, you would still be left with one credit card that is 9 years old – and that’s great. But if you hadn’t cancelled the other credit card, then 7 years down the line you would have a credit card that is 17 years old – and that’s even better. In this case, cancelling your oldest card could have a negative impact on your credit score, which means it may be worth it to keep the older card open. If your two credit cards were close in age, then the affect would be minimal. Of course, keeping your oldest credit card open for credit score purposes only makes sense if it has no annual fee.
One factor that could result in an immediate impact on your credit score when cancelling a credit card is your credit utilization (use of available credit*). To maintain a good credit score, it is wise to utilize a maximum 35% of your available credit at any given time. For example, if you have two credit cards, both with a $10,000 credit limit, and between the two have a $6,000 balance, then your credit utilization is 30% ($6,000/$20,000). If you decided to do a balance transfer and cancel one of your credit cards, your credit utilization would rise to 60% ($6,000/$10,000); this is the main way in which cancelling a credit card can affect your credit score.
One way to avoid this is if you were cancelling a credit card while applying for a new credit card with the same limit, or getting a credit limit increase on a current card. The key point to remember is that, in most situations, you do not want to lower the amount of available credit you have. Also remember that, before you attempt to cancel a credit card, it is important to pay the balance off in full.
Ultimately, if you want to cancel a credit card, you are able to do so without dramatically lowering your credit score. Your score would only dramatically drop if you started to miss payments, so always pay your bills on time even if it’s just the minimum payment.
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