I wrote about the common misconception that applying for credit cards affects your credit score.
While a query on your credit report can cut your score by a few points in the short term, the reality is that there are several metrics that can be positively impacted by opening new credit cards, including lower credit utilization and higher payment history.
Most importantly, you don’t use too much of your credit, that you make your payments on time, and that you maintain a reasonable average age on your credit card accounts.
In this post I wanted to answer another question that I keep getting – How does closing credit cards affect your creditworthiness?
While I currently have over 25 credit cards, I sometimes open and close cards as my spending patterns and card benefits change over time. Let’s take a closer look at how your creditworthiness affects your card closing.
How is your credit score calculated?
First, let me give you a quick look at calculating your credit score (if you already know, definitely skip this section).
Your creditworthiness is made up of the following components:
- 35% of your score is your payment history (the percentage of payments you made on time).
- 30% of your score is your credit use (how much credit you use compared to your total limits)
- 15% of your score is your credit age (the average age of your open accounts)
- 10% of your score is the types of loans you are using (how many different types of loan applications you have)
- 10% of your score is your requests for new credit (how often you have applied for credit)
If you’re getting your payments on time, you shouldn’t be using too much of your funds and keep your average account age pretty old, that’s right there 80% of your creditworthiness.
How does your credit affect when you close a credit card?
When you open a card, you get a request that counts as a small “thing” on your credit score (although it can go up due to other factors). There is no such thing when you close a card.
Closing a credit card can affect your credit score in a number of ways.
Your credit usage can increase as you close cards
Closing a credit card can increase your credit life. This metric is calculated based on your total available credit. So when you close a card, your total available balance will decrease.
Let’s use the following example:
- An individual has two credit cards with a credit line of $ 5,000 each for a total of $ 10,000 in available credit
- This person spends an average of $ 3,000 per month on their credit cards
With both cards open, that person’s average occupancy is 30%. However, if the total available balance suddenly hit $ 5,000 (due to a card closure), that person’s card usage rate would double to 60%.
There are several ways you can mitigate the effects:
- You can withdraw your balance before the closing date of the bank statement. This is because your occupancy is calculated based on your balance on the balance sheet date of the bank statement
- When you close your card, you can try transferring your line of credit to another card so that you can keep the same total amount of credit. This is only possible if you have a different card with the same issuer and if you are transferring personal-to-personal or business-to-business (even then this is not always possible).
What happens to your average age of accounts when you close cards?
A common point of confusion is what happens to your average age of accounts when you close a card. The reality is that this metric can be influenced over the long term. However, if you close a credit card, it will continue to show up on your credit report (and will continue to age) until it wears off after up to 10 years.
Let’s use the following example:
- One person has two credit cards
- One credit card has been open for two years and another credit card has been open for four years, which means the current average age of the person is three years
If you canceled the card you had for two years, what would your average bank account age be in two years?
- A card would be six years old
- A card would be four years old (the closed card continues to grow in the two years since it was closed)
That means your median age is now five years, which is better than it was before. At some point (up to 10 years after you close the card) it will fall off your account and no longer add to your average age, but that’s not immediate.
Example: How I am not greatly influenced by closing cards
Now let me use my situation as an example:
- I have more than 25 credit cards
- I have a lot of credit available and I usually pay my balance before the statement is closed, so my occupancy is only 1%
- My average account age is almost six years
For the broader context, here are some of my credit factors:
In my case, I have a sufficiently established history that opening or closing a card has minimal impact on my creditworthiness.
One thing that really helped is that I have a couple of very old cards, including one that has been on my credit history for 33 years (see this post for how to do that). I expect that closing this card would have a negative impact on my score in the long run once it fell off my report.
Strategies for Minimizing the Effects of Credit Card Closing
While there is no magic formula here, I generally have a few takeaways and recommendations:
- Hopefully this shows the value of keeping some cards with no annual fee for long periods of time as it can really help your credit score
- In the event that you run out of value on a card you’ve had for a long time, call and see if there is an option to downgrade it to a no annual fee card so that you can at least keep your credit rating
- If you are canceling a card, check to see if there is an option to transfer the line of credit to another card you have. This can also help keep your credit utilization down
- If you are badly affected by an increased credit load, pay almost your entire credit card bill before the bank statement even closes, as that way it indicates a very low load
As a general rule of thumb, don’t be afraid to close credit cards as part of a balanced strategy. The key is to make sure that canceling a card doesn’t add materially to your credit usage (although you can work around this in part by paying your balance before the bank statement is even closed).
In the event that you’ve had a card for a long time, it can be very valuable to hold onto. You can always call the credit card company and see what downgrade options are available to you.
If you are not very familiar with credit cards, this is another reason why it is so valuable to purchase lucrative cards with no annual fee at the beginning of your credit journey so that they can improve your creditworthiness in the long term. After all, maximizing credit card rewards is a marathon, not a race.
What is your experience with the impact of credit card closures on your creditworthiness?