Americans owe over $900 billion in credit card debt (El Issa, 2019), and credit card interest rates are on the rise – now over 15 percent (Commercial bank interest rate on credit card plans, accounts assessed interest, 2020).
So, if you are on a mission to reduce or eliminate your credit card debt (go you!), you may be thinking you should close out your credit cards. However, you need to know that doing that may have several effects, some of which may not be what you would expect.
There are times when canceling a card may be the best answer:
1. A card charges an annual fee
If you are being charged an annual fee for the privilege of having a certain credit card, it may be better to cancel the card, particularly if you don’t use it often or have other options available.
2. You cannot control your spending
If “retail therapy” is impacting your financial future by creating an ever-growing mountain of debt, it may be best to eliminate the temptation of buying on credit.
Then there are times when closing a credit card may not make much difference, or could even hurt your score:
1. Lingering effects: The good and the bad
Many of us have heard that credit card information stays on your report for 7 years. That is true for negative information, including events as large as a foreclosure. Positive events, however, stay on your report for 10 years. In either case, canceling your credit card now will reduce the credit you have available, but the history – good or bad – will remain on your credit report for up to a decade.
2. The benefits of old credit
Did you know that one aspect factored into your credit score is the age of your accounts? Canceling a much older account in favor of a newer account can leave a dent in your score, and we know that canceling the card will not erase any negative history less than 7 years old. So, it may be best to keep the older credit account open if there are no costs to the card. Another point to consider is that the effects of canceling an older account may be magnified when you are younger and have not yet established a long enough credit history.
Credit utilization affects your credit score
Lenders and credit bureaus not only look at your repayment history, they also look at your credit utilization, which refers to how much of your available credit you are using. Lower usage can help your credit score while high utilization can work against you.
For example, if you have $20,000 in credit available and $10,000 in credit card balances, your credit utilization is 50 percent. If you close a credit card that has a credit limit of $5,000, your available credit drops to $15,000 but your credit utilization jumps to 67 percent if the credit card balances remain unchanged. Going on a credit card canceling rampage may have negative effects because your credit utilization can skyrocket.
If unnecessary spending is out of control or if there is a cost to having a credit card, it may be best to cancel the card. In other cases, however, it is often better to use credit cards occasionally, and make sure to pay them off as quickly as possible.
References
Commercial bank interest rate on credit card plans, accounts assessed interest. (2020, 8). Retrieved from Federal Reserve Bank of St. Louis website: https://fred.stlouisfed.org/series/TERMCBCCINTNS
El Issa, E. (2019, December 2). NerdWallet’s 2019 household debt study. Retrieved from https://www.nerdwallet.com/blog/average-credit-card-debt-household/
Rivera-Goitia, H. (2020, July 31). The effects of closing a credit card. Retrieved from https://wfgconnects.com/helgariveragoitia/blog
Filed Under: Life Insurance | Tagged With: Credit Cards, Interest, Saving