Why You Should Think Twice About Canceling A Credit Card
September 2, 2008
If you’re paying off credit card debt, one of the most motivating things is getting a card completely paid off and crossing it off your list of outstanding debts.
Once you’ve done this it can be tempting to start charging on that card again, so a lot of people cut up the card or cancel the account entirely.
Cutting up the credit card may help you avoid spending more money on it, but canceling the account completely can actually damage your credit score in some cases.
One of the factors that is used by the credit reporting agencies to calculate your credit score is the amount of outstanding debt you have relative to the total amount of credit you have available to you.
So let’s look at an example…
Let’s say you have two credit cards, one with a credit limit of $3000 and one with a credit limit of $5000. You have just finished paying off the card with the $3000 limit and the card with the $5000 limit has an outstanding balance of $4000.
So your total outstanding debt is $4000, with $8000 in credit available to you in total. So you have a 50% debt/credit ratio.
Now if you cancel the $3000 card, you still have $4000 outstanding but only $5000 total credit available. That means your debt/credit ratio jumps to 80%.
So for the purposes of calculating your credit score, the component that this calculation is used for has jumped from 50% to 80% outstanding debt. If all else is equal, this will most likely cause your credit score to drop.
You would be better to keep that credit card active - but stop using it - until you have paid off the other card as well. At that point, canceling one of the cards will not hurt your score since you wouldn’t have any outstanding debt, meaning the ratio will be the same no matter how much total credit is available to you.
This is a simplified example, since most people will have other debts and credit available to them, but it shows how canceling a zero-balance card can affect your overall financial health.
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