Monday, December 29, 2008

Closing Credit Cards – Is It A Good Idea?

Updated 04/20/2010

Q.
Should I close unused credit cards or leave them open?
A. Although it's usually it’s better to leave unused personal credit cards open, it often doesn't make much of a difference.

This article discusses the effect closing a credit card has on your score. You might want to leave a card open for other reasons, like having access to the credit line etc.

There are two main reasons why closing a credit card can lower your credit score:
1. It lowers your total available credit.
2. It shortens your credit history. Don't worry about this too much, because it won't affect your credit for at least 7 years, when this card might drop off your credit report. Until that happens, the card will still be used to calculate your credit history.

Having too many cards will also slightly lower your credit score. So, if you have more than, say a dozen personal cards, closing some cards, if they are closed the right way, can actually raise your score. Whatever you do, I would recommend to always have at least 3-4 personal credit cards. It’s better if they are from different issuers so that even if one card closes you down, you will still have other cards.

There is another reason to close some unused credit cards. Back when credit was extremely easy to get, having lots of cards wasn't a big deal. Now, however, when it seems that credit card companies are looking for excuses to close people down or lower their credit lines, you might want to play it safe and close some cards if you have more than around 10 personal cards. People with lots of credit cards seem risky to credit card companies.

The right way to close credit cards:
  • Don’t close your last card with a major bank, as you never know when you might need them.

  • If you have more than one card from the same issuer (e.g. Chase, Amex, Citi), and you don't need both of them, cancel the one you don't need.

  • Close the newer cards. Leave your oldest cards open. As I wrote above, it's not as important as people make it out to be.

  • Move the credit over to an older card before canceling. Besides for helping your score, this is a good idea because now you have a higher credit line on your credit card in case you need to ever make large purchases.

  • If you earned a signup bonus for opening the card, wait at least six months before closing the card. Some companies might take away the bonus if you close the card too soon.

  • Many people don't realize that it makes a difference which card you leave open and which you close when combining cards (also called ‘consolidating accounts'). Just because you are combining credit cards, it doesn't mean they become one card. One of the cards will be 'closed' and that will be reflected on your report, while the other card will remain open. Make sure the card that is closed is the newer one.
Some terms explained:
  • Lowering your available credit:
    There are two issues with a card reporting a lower credit line to the credit reporting agencies: 1) The debt to credit ration on this specific card changes. Whenever you carry a balance, you will be using up more of your available credit than before. 2) The debt to credit ratio of all you personal cards combined changes. If between all your cards, you have an overall credit line of say, $30,000. If you close a card that has a $10,000 credit limit, you will now only have $20,000 total available credit.

  • Shortening your credit history:
    Your credit history means how old your average credit card is. If you close one of your older cards, you will shorten your credit history. The closed card will continue to stay on your credit report even after it closed for at least another 7 years. So it will take a while until it has an effect on your score, and by then you will have other old cards.

Notes:
  1. This is a general answer and might not apply to every situation. Feel free to email me with specific questions at dealreviews@gmail.com.
  2. The number of cards I mentioned throughout the article isn't necessarily exact. Fico doesn't release to the public exactly what causes scores to go up and down. My assumption is based on many cases that I know about.
  3. Business cards don't show up on your report in the first place, so closing them won't make a difference at all to your score.
  4. It’s not always possible to consolidate all cards. If that's the case by you, just make sure to leave open the card with the most credit, and if possible, the oldest card.
  5. Citi AA cards don’t report your credit line at all. So if you’re closing a Citi AA card, it won’t help your score by moving over credit. The only thing it will help with, is it will give you a higher credit line. If you’re going to move the credit to a Citicard that does report your credit line, it will raise your score!
For more on credit, read the Credit Education Series.

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