While getting a credit card can be a sign of financial responsibility, it can also turn into a burden. If you've run up a pretty big balance, and then had to work to pay it off while also paying a lot in interest, it can be tempting to just close the account and be rid of it. However, closing your credit card could actually end up hurting your credit score.
Managing Utilization
According to FICO, the second most important factor in your credit score is how much you owe relative to your total credit limit. Lenders like to see that you use a small proportion of your total available credit. The lower your utilization rate, the better it can be for your score. If you close a credit account, you lower your total credit limit, which has the effect of increasing your utilization rate. For instance, if you owe $1,000 and have a credit limit of $4,500 across three cards, your utilization is 22.2 percent. Closing a card with a $1,800 limit would drop your overall limit to $2,700, making your $1,000 balance equal 37 percent of your total limit.
Your Credit History
Closing a credit card can also impact your credit history. For as long as you have a card account open, and you are using it responsibly, it can play a role in giving you a better credit score. When you close the account, it doesn't immediately drop off of your credit report. However, it will eventually drop off of your credit report and stop contributing to your credit profile. According to the Experian credit bureau, a credit account with no negative information in its history disappears after being closed for 10 years. At that point, the account will no longer help your credit score.
When to Close
There are times when it makes sense to close a credit card. For instance, if you are paying an annual fee for a card that you don't ever use, you might be better off cancelling it. To safely close a card, it's best to check to see that it won't have a big impact on your utilization rate. For instance, if you usually carry $1,000 in balances and you have four cards with a combined limit of $14,000, closing a card with a $2,500 limit and dropping your overall credit limit to $11,500 won't make a big difference since your utilization will only go from 7.1 percent to 8.7 percent.
Avoiding Residual Interest Problems
When you pay off and close your credit card, keep an eye on your balance. You could still owe a little bit of money for what the industry calls "residual interest." This happens because interest keeps accruing between the date of a statement and the date you pay it. While the residual interest might not be a lot of money, not paying it could leave you with a late payment and a ding to your credit. To avoid this, call your card issuer and ask what your balance will be a week or two in the future, then pay that amount. That way, you will cover the interest that gets charged for that period of time.
References
Writer Bio
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.