Canceling a credit card typically does have a negative effect on your credit score because it reduces your debt utilization. However, you need to consider the potential benefits of canceling a card, including saving on maintenance fees, in comparison to the negative implications to your credit score when making a decision.
Credit Score Basics
Your credit score is an evaluation of your overall credit worthiness as an individual borrower. Your score is important to potential lenders when considering whether to loan you money and what rates and terms to set. Three major reporting bureaus provide credit scores that are used by lenders. Though each rating system is unique, they are all based on the FICO scoring model, names after its creator, the Fair Isaac Corp. Credit scores are influenced by a number of factors such as loan and payment history, debt utilization, types of credit and length of credit.
Debt Utilization
The reason your credit score is generally hurt when you cancel a card with a zero balance is that it reduces your debt utilization. According to the MyFICO breakdown of your credit score computation, about 30 percent comes from your use of credit relative to available credit. Debt utilization is the percentage of available credit currently in use. The lower your debt utilization, the better your score. If you cancel a card with zero balance and a $10,000 limit, for instance, you lose $10,000 of available credit, reducing your utilization.
Benefits of Canceling
In the scenario proposed in the question, you benefit from canceling your card because you no longer pay monthly fees. Many card providers charge monthly or annual fees for using the card. In his Bankrate.com article "Cancel a card, hurt your credit score," author Gregory Taggart also cites Craig Watts of the Fair Isaac Corp., who indicates that canceling cards is sometimes necessary to get your poor spending and credit habits under control.
Weighing the Options
Ultimately, deciding whether to cancel depends on credit card variables and your personal credit situation. Canceling a lower-balance card to avoid hefty fees is more sensible because you have less impact on your debt utilization. If your credit score is excellent and you have large available credit, losing a few thousand on a single card would have minimal impact. And, as Taggart noted, the benefits of improved credit habits may have more impact on your credit score than keeping a high-balance card to preserve a few credit score points.
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