A question I hear often is, “Should I close out old credit cards that I don’t use anymore?” Is that a good idea? First we will talk about why closing a credit card may not ever be a good idea and then we can look at some reasons to close out a credit card.
Closing credit cards should never be taken lightly. Closing a card removes that available balance from our overall available credit. Removing these available balances by closing the cards can reduce our FICO/Credit score. 30% of your score is based upon the ratio of used vs. available credit. Reduce the ratio and reduce your FICO score.
Example: A person has $20,000 in available lines of credit and has $5,000 charged up. They are using 25% of their available credit; a 1:4 ratio of used credit to available credit. Then they close a credit card with a $5,000 available balance. This decrease in their available credit, from $20k to $15k, increases the percentage of credit they are using to 33% and takes them to a lower and less desirable 1:3 ratio in credit usage. This will lower their FICO Score.
Closing cards can be a big deal if consumer credit cards are your only form of credit. If you have other types of credit, a mortgage or car loan for example and have other credit cards, closing one card may not be a big deal. But if one has a thin or minimal credit file, it could be detrimental.Also, the history of your card usage will drop from the report after 18 months and it will no longer be a factor in your FICO score. Ouch!
Why close a card? Fees. Some cards have instituted annual fees; one must pay an annual fee just to possess the card. These annual fees can range from $25 to $100 depending on the card and its features (rewards, vacation insurance, travel services, etc.). If the fee is too much for you to afford or you just won’t pay it on principle, then it might be time to look for a new card to replace this one or close it altogether.
Interest rates can be an issue for people who carry balances. An increase in the APR of 3%, say from 15% to 18%, can cost a cardholder an extra $150 over a year on a $5,000 credit card balance. If the APR is a concern, I would recommend finding a lower rate replacement. Credit card issuers will often offer reduced rates for balance transfers. This may be an opportunity to transfer the balance to a new card with a lower rate and close the old card.
The card has been stolen or compromised by an identity thief. Good reason to close it. Often your card issuer will offer to replace the card with an entirely new account, transferring your balance to the new account.
Sometimes people get tired of making payments and are simply through with debt. They will cancel their cards to prevent further accumulation of debt. If you are ending your relationship with debt, that may be a good reason to close a card or two. That being said, keep one general purpose card such as a Visa or Master Card open for emergencies. Go to McDonalds once every six months and buy yourself a Happy Meal for lunch. Pay that bill at the end of the month and your card will remain active. Do this every six months to keep that card active. You never know when you will need it!
* * *
Our next Financial Education workshop will be taking place at our Sunnyvale Financial Center at 563 E. El Camino Real in Sunnyvale, next to Togo's Sandwiches. To attend, please RSVP with Greg Meyer at firstname.lastname@example.org or 408-365-6328.
Credit Myths and Repair - Learn how to access your credit report from all three credit bureaus and your credit score for free. How do inquiries effect your score? What happens to your credit after you pay a collection? Have a late payment? Get a divorce?
6:30PM - 7:30PM on Oct. 23rd
Sunnyvale Financial Center
Meriwest Credit Union
November 9th and 10th at the Meriwest Credit Union Main Office
5615 Chesbro Ave, San Jose CA 95123
Come to see our wide selection of late model, gently used cars offered at bargain prices by our MCU approved dealers.