Canceling credit cards can seem like a good strategy to improve your credit profile. However, if you carry a credit balance, canceling cards can actually hurt your debt ratio and lower your credit score. Canceling cards can also hurt other factors that make up your credit score, such as the age of your credit accounts. Unless you are paying a fee on a card that you don't use, canceling cards can cause more harm than good.
Your debt ratio is the percentage of your available credit that you actually use. For example, if you have a credit line of $10,000 and $4,000 in outstanding debt, your debt ratio is 40 percent. In the parlance of the credit card industry, a debt ratio is often referred to as "credit utilization." The well-known FICO credit scoring model, developed by the Fair Isaac Corp., considers credit utilization to be part of the "amounts owed" portion of your credit score. As the amounts owed category comprises 30 percent of the FICO scoring model, keeping your debt ratio low is an important factor in increasing your credit score.
Cancellation and Debt Ratios
When you cancel a credit card, the available limit on that card disappears from your credit report. If you keep the same amount of debt, your debt ratio will increase since you will be using a higher proportion of your remaining credit. For example, if you have $10,000 in available credit but cancel a card with a $5,000 credit line, your available credit will drop from $10,000 to $5,000. If you have $4,000 in outstanding debt at the time of the cancellation, your credit utilization will skyrocket from 40 percent to 80 percent. Based on the FICO scoring model, you should expect your credit score to take a hit under this scenario.
Paying Down Debt
If you want to keep your debt ratio stable after canceling a credit card, pay down some of your outstanding debt. Carrying $4,000 of debt on a $10,000 credit line gives you the same 40 percent credit utilization as having $2,000 of debt on a $5,000 credit line. Your score might actually see a bump up in the latter scenario since the amount of your overall debt would decrease, helping the "amount of debt" portion of your FICO score.
Depending on your personality, canceling a credit card may be a good idea even if you suffer a small dip in your score due to a higher credit utilization percentage. Having extra credit cards can result in overspending, increasing both debt levels and credit utilization. If having an open credit line is going to tempt you to overspend, canceling the card might be a better option, according to credit reporting agency Experian.
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