Whether you have too many and want to cut back, or 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 can, 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 score, the better. A high credit score means you’ll be seen as “creditworthy” and more likely to effectively manage debt and repay loans on time. Your score matters because if you ever plan on getting a loan in the future – like 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 at least 600 you’ll be in good standing, but every lender has different criteria when approving loans and your credit score is just one, albeit important, part of the equation.
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, and student loans. How you use your credit is ultimately what determines your credit score and is calculated based on the following key criteria:
- Payment history: Whether or not you make payments on time is the single-most important factor that goes into calculating your creditworthiness and accounts for roughly 35% of your total score.
- Credit utilization: Managing your credit utilization ratio is crucial since it counts for 30% of your credit score. Your utilization ratio is calculated based on how much credit you’re using relative to what you have available. For instance, if you have a total credit limit of $5,000 and you regularly carry a balance of $1,000, your utilization ratio is 20%. Maintaining a ratio below 30% is recommended.
- Length of credit history: Generally, creditors like to see that you have a history of managing credit, which is why the duration of your credit history accounts for 15% of your credit score.
- Number of inquiries: While the number of credit inquiries only counts for 10% of your credit score and the occasional credit check won’t have a long-lasting effect on your score, you should avoid sporadically opening several new credit accounts at once as lenders may consider this suspicious activity and wonder why you’re trying to access so much credit all at once.
- Types of credit: By having a more diversified credit mix – like credit cards, a mortgage, automobile loan etc. – lenders will have more information about your relationship with credit and how you manage debt. That said, credit mix only accounts for roughly 10% of your credit score and you shouldn’t needlessly open new credit just to chase a higher score.
How cancelling a credit card hurts your credit score
If you are considering cancelling a credit card, there are two major ways it could affect your credit score:
1. Credit utilization
Credit utilization measures how much you owe relative to your total credit limit, and the general rule is the lower your credit utilization, the better. Lenders consider it a good sign if your card balance is under 30% of your total credit limit since it suggests you’re not over-leveraged and can keep up with payments.
By cancelling a credit card, your total credit limit will decrease causing your credit utilization to rise. That could have a negative knock-on effect on your credit score.
Here’s an example to help explain:
- Let’s say you have just two credit cards that each have a limit of $4,000 – or a total combined limit of $8,000.
- If you carry a $2,000 balance, you’re using up 25% of your total $8,000 credit limit – which means your credit utilization is below the recommended 30% threshold.
- But, if you cancel one of those cards, your total credit limit would decrease and you’d be carrying a balance of $2,000 with a limit of $4,000. That’s a credit utilization ratio of 50%.
The effect on your credit utilization ratio is usually more pronounced if you’re closing a card with a high credit limit or owe a large balance on your other cards.
As weird as it sounds, it could be a good idea to increase the credit limit on the credit card you want to keep before cancelling the card you don’t use anymore, as that’s a way to keep your utilization ratio down. It can also help if the card you’re cancelling has a small credit limit in the first place or you already have a high total credit limit across multiple credit cards and loans. The key point to remember is that, in most situations, you do not want to lower the amount of available credit you have.
2. Credit history
Cancelling a credit card won’t have an immediate effect on the length of your credit history, but it could potentially hurt your score down the line. That’s because even after you cancel a credit card, the account will stay on your credit history for up to 10 years.
It’s the reason why many experts recommend trying to hang onto your oldest credit card – especially if you have a short credit history. Generally though, if you have a long credit history, closing your first card won’t have as much of an impact.
Here’s an example to help explain:
Let’s say you cancel your first-ever credit card that is 10 years old and leave open your second credit card that is just 2 years old. After 10 years, your first card is removed from your credit history and you would still be left with your second credit card which would now be 12 years old – and that’s great. But if you hadn’t cancelled your first credit card, then 10 years down the line you would have a credit card that is 20 years old – and that’s even better. In this example, keeping your oldest card would have a more positive 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 effect would be minimal.
The silver lining
Even though the above two factors account for a significant portion of your credit score calculation, you can cancel one of your credit cards without dramatically lowering your credit score over the long term as long as you do the right things (more on that in the section below).
In fact, there are immediate factors that can cause your score to drop more significantly and quickly, like if you missed two payments in a row. For lenders to consider you creditworthy, you need to make your payments on time. Even if you’re in a cash crunch, making the minimum payment is better than not making any payments. Yes, your credit utilization ratio would go up, but it’s still better than missing payments.
Do’s and Don’ts of closing a credit card
There are good reasons for closing a credit card. Whether the temptation of using credit is leading you to constantly overspend and rack up interest, you have so many cards that you’re losing track and missing payments, or you want to get rid of a card with a low limit and higher than normal interest rates, cancelling can be the right move.
If you plan on cancelling one of your credit cards, consider the following do’s and don’ts to minimize the impact on your credit score.
- Completely pay off your balance: Make sure the credit card you’re cancelling has a $0 balance. The last thing you want is an outstanding payment on a card that you’ve just cancelled. If paying it off completely isn’t an option, you could transfer the balance to another card that you plan on keeping (though you could owe an additional transfer fee of up to 3% of the balance). You may also want to wait a few weeks before cancelling for any pending payments to appear, and to be extra safe, follow up and confirm with your card issuer that your balance is at zero dollars before the final cancellation goes through.
- Cancel recurring payments: Make sure to change any recurring payments that are being charged to the card you’re about to cancel to another credit card you plan to keep.
- Consider a product switch: If you just want to avoid paying the annual fee on a credit card you rarely use, don’t cancel and request for a product switch to a no-fee card from the same card issuer instead. Your credit history and utilization will remain the same.
- Use your points: Before you cancel your credit card, you’ll also want to ensure you redeem any remaining points that you have since you’ll lose them once you cancel. If you can’t use them right away, see if there are any rewards programs that you can transfer them to instead. Note that if you’re cancelling a co-branded credit card such as Aeroplan, you won’t lose your points if you cancel your card as the miles are tied to the loyalty program, not the credit card itself.
- Confirm the cancellation: Once you’ve cancelled your card, you should receive a letter in the mail confirming your request. If you haven’t received anything and you’re still able to see the card in your online account, you’ll want to follow up with the credit card provider to ensure your account has actually been cancelled.
- Cancel your oldest card: Try to avoid closing your oldest credit card since it has the highest likelihood of affecting your credit history. If this card is a no-fee card, there’s no harm keeping the card open. If you’re paying a fee, ask to product switch to a card that won’t cost you anything.
- Cancel multiple products: Closing several credit cards at the same time also isn’t advised. It could easily hurt your credit utilization ratio, but more importantly, it looks suspicious in the eyes of the credit reporting bureaus.
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