If you've worked hard to pay off a credit card debt and plan to stop using the card, it may seem like a logical idea to close the account, especially if your payment history on the card is less than stellar. But that's actually a bad idea. Closing credit card accounts can hurt your credit score, so consider the effects carefully before closing an account.
Since closing a credit card account can impact your debt ratio and the length of credit history, you should carefully consider your overall credit profile and financial situation before deciding to close a paid off credit card.
Impact on Your Debt Ratio
One of the factors that goes into your credit score is how much debt you have relative to your available credit. If you have $30,000 of available credit and $3,000 in debt, your debt ratio is 10 percent.
Say you have three credit cards, each with a limit of $10,000, and you have a $1,500 balance on one, $1,000 on another and $500 on a third. If you pay off the smallest balance and then close that card, you have $2,500 of debt and a $20,000 credit limit. Your debt ratio is now 12.5 percent, which makes you a higher credit risk and can lower your credit score.
Length of Credit History
Another factor in your credit score is the length of your credit history, and a popular misconception is that by closing a credit card you will lose the payment history of that card. As long as the card history remains on your credit report, it is calculated in your credit score. You cannot eliminate a poor payment history by closing the account, nor will you lose a positive history.
However, if you close your oldest card, it could put you in a new age range, which is an important criteria, consider the length of your credit history is an important part of your score.
Considerations for Closing the Account
If you only have a couple of credit cards, closing one may not only cause your debt ratio to increase, it may also put you in a bind if you need to use credit in an emergency. Applying for credit cards can ding your credit score slightly, so if you have to apply for another card in the future, it could bring down your score.
What You Should Do
If you have several credit cards with high credit limits, closing one after you pay it off is not going to make much difference to your credit score. However, the better option is to simply take the card out of service. Store it in a safe or tuck it in the back of your sock drawer. That way, it's still available in case of emergencies.
If necessary to avoid inactivity fees, use the card every couple of months for small purchases and pay them off immediately.