Consumers have plenty of good reasons to close credit card accounts, including annual fees, increases in interest rates and trimming down on the number of cards to carry. In addition to thinking about these factors, you should also weigh the impact that closing a credit card can have on your credit score. Especially if the card has a balance, the move could seriously impact your score.
Credit Utilization Basics
The main way that closing an account with a balance affects your score is through credit utilization. Your utilization is the ratio of your balance to your credit limit, both on each individual credit card and overall. For example, if you have a card with a balance of $2,500 and credit limit of $6,000, your utilization is about 42 percent. Higher utilization leads to lower credit scores. To avoid damaging your credit score, you should aim for utilization of about 30 percent or less.
Individual Card Utilization Effects
When you close a credit card account with a balance, you still have to pay that off. The card will continue to affect your utilization for as long as it has a balance. The utilization on that card depends on how your credit card issuer reports the credit limit on a closed card. Some issuers continue to report the limit on the card before you closed it, which means that your utilization will decrease, and therefore help your score, as you pay down the balance on the closed card. On the other hand, some issuers reduce your credit limit as you pay down the balance. For example, if you close a card with a balance of $2,500, the issuer will reduce your limit to $2,500 as well. If you pay off $500 of that debt, the issuer will then reduce your limit to $2,000 to match your balance. Therefore, your card will show utilization of 100 percent until you totally pay it off, hurting your score that whole time.
Overall Utilization Effects
Closing a credit card account, whether it has a balance or not, can affect your overall credit utilization ratio. Calculate your overall utilization by adding up all of your balances, including the one on the closed card, and dividing that by the sum of all your credit limits, including the closed card. As described above, the limit shown on the closed card will vary depending on the issuer as you pay off the balance. Regardless of how the issuer handles the limit while you still have a balance, the limit will drop to zero when you finish paying off the balance. If the card you closed had a high credit limit that was helping to lower your overall utilization, losing all of this available credit will increase your overall utilization.
Tips
You can close an account without hurting your score at all, but you must pay it off first. In addition, if the utilization on that particular card is lower than your overall utilization, you also need to pay down some of your other balances so your overall utilization does not increase when you lose the credit limit on the account you close. If for some reason you need to close an account with a balance, your score will probably drop. However, your score should bounce back as soon as you pay off the balance and reduce your utilization on your other cards.
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