There are many common misconceptions and myths about credit cards and credit scores. One common area of misunderstanding is what happens when you close your credit card. A lot of people think that it hurts your credit score to close a credit card but that’s not necessarily the case. So here’s the truth about what happens to your credit score when you close your credit cards and some things you should consider.
This article will be analyzing the FICO method for calculating credit history. There are other methods, such as the Vantage model that do things differently, so this will not apply to all forms of credit scores. However, because FICO scores are the primary credit scores that matter for most lenders (at least at this time), I’m focusing on them.
How your credit score is determined
The first thing you need to know is how your FICO credit score is determined. Your credit score is determined by the following factors.
- Payment History (35%)
- Utilization (30%)
- Credit History (15%)
- New Credit (10%)
- Mixed Credit (10%)
Closing your credit cards has the ability to change almost all of those factors and I will explain how below.
1) Payment history
The bad thing about cancelling a credit card is that you’re not going to be able to continue to build up your credit payment history with that card. Cancelling a card won’t necessarily negatively impact this category but it will prevent you from further building it up. Since payment history is the #1 factor in determining your credit score, that’s definitely something to consider.
Utilization is your credit to debt ratio. You find this by dividing the amount of debt you have by your total credit limit. So for example, if you have a $10,000 total credit limit and owe $5,000 in debt, then your utilization is at 50%. It’s recommended to keep this number under 30% but I also recommend keeping it under 10% for maximum benefit to your score.
This factor can be affected immediately when you cancel a card because you’re decreasing the credit limit (or denominator) in your equation. So let’s assume you have two credit cards that form your $10,000 credit limit, both with $5,000 limits. As soon as you cancel one, your new utilization will jump from 50% to 100%, which is very bad!
If you absolutely must cancel a card then I recommend closing a card with the smallest balance or asking if you can transfer credit from that card to another card if you have two or more cards with the bank. (Make sure that this will not incur an additional hard pull on your credit, however.) Banks, such as Chase bank, should allow you to do this with no problem.
3) Credit history (average age of accounts)
Average age of accounts (AAOA) is one of the most confusing factors for credit reporting and understandably so. AAOA fits into the “credit history” category. It’s important to remember that for FICO purposes these factors combined only affect 15% of your total credit score. Thus, even if they were to change, the impact would not be as substantial as payment history and utilization, which together account for 65% of your credit score.
The credit history category consists of the of the following factors:
- Longest opened account
- Average age of account
- Time since newest account
- Time since each account was last used
The most important of these factors is the age of the longest opened account while average age of accounts is second. The time since newest account and time since each account was last used carry much less weight than the other factors, so I don’t think you need to focus on them too much.
4) Mixed credit
By cancelling a credit card it’s possible that you’re reducing the mix of your credit. For example, you may only have student loans and auto loans on your credit report once your credit card drops off. If that’s the case then you still shouldn’t worry. That’s because this “mixed credit” category matters the least out of all the categories and it really is only important for people trying to bolster their credit scores above 800 — I wouldn’t make this factor determine the outcome of cancelling a card.
So what do these factors mean?
First, if you have a thin payment history (maybe only a couple of years) you should try to avoid cancelling your card and try to continue to build up that payment history.
Second, since your longest opened account matters the most for the credit history category, you should always do whatever you can to keep your oldest account open. Only under extremely rare circumstances would I ever close my oldest account.
Third, when it comes to average age of accounts, it gets confusing. For whatever reason, FICO includes closed accounts to calculate your average age of accounts and they do this for up to ten years. So yes, that means that even if you close your account, it will still continue to age for ten additional years. After that, your closed accounts drop out of the equation.
Here’s an example of how that works.
Let’s start with the basics.
Assume you have two credit cards: a 2 year old credit card and a new one just opened up at the crack of dawn this morning.
- 2 year old account
- 0 year old account
Your average age of accounts is now 1 year since (2 + 0)/2 = 1 years.
Now let’s say you add in another card 5 years from today. Your credit cards now look like the following:
- 7 year old account
- 5 year old account
- 0 year old account
Your average age of accounts is now 4 years since (7 + 5 + 0)/3 = 4 years
Now let’s say that on the same day you opened your third credit card, you closed your 5 year old credit card account. According to FICO, this account will still age for the next ten years.
So let’s assume you don’t get anymore cards and we move forward 9.999 years to the day before your ten year anniversary of closing your card. This is what your accounts look like now.
- 17 year old account
- 15 year old account *closed*
- 10 year old account
Your average age of accounts is now 14 years since (17 + 15 + 10)/3 = 14 years.
However, the very next day your 15 year old account will drop off changing the make-up of your credit score to the following:
- 17 year old account
- 10 year old account
Your average age of accounts is now 13.5 years since (17 + 10)/2 = 13.5 years.
Thus, unless you’re closing very old accounts and there’s a big age disparity between a limited number of total accounts, the impact of closing a credit card on your average age of accounts may not be very substantial even in the long run. However, it would always be a good idea to keep those accounts from falling off your report after ten years if you think you’ll constantly be applying for new credit cards due to travel hacking.
First, for purposes of your FICO score, cancelling a credit card has very minimal immediate impact and can even have a minimal long-term effect on your AAOA since it will continue to age for ten years. Although this is true, if you think you’re going to continue to apply for new credit cards each year, you still want to keep your accounts open as long as possible to preserve your AAOA.
Second, it’s definitely important to always try to keep your oldest account open to preserve your oldest account age, but It’s likely just as important to monitor how cancelling a card will affect your overall utilization.
Third, it’s actually opening up new accounts that will have more of an immediate effect on your credit history since those will bring down your AAOA instantly. This is why I recommend keeping your accounts open because the fewer accounts that fall off in ten years, the less damage a new account will do to your AAOA. This is also why I recommend looking into applying for business cards from banks like Chase, Amex, and Citi since those new credit card accounts do not report to your personal credit report and thus do not bring down your average age of accounts.
Always remember to explore other options
There are almost always different ways to to downgrade or product change a credit card to a no annual fee version. Thus, if you’re thinking about cancelling a card because you don’t want to bother with the annual fee then make sure there are no other options for changing the card. It might turn out that with a quick phone call to the bank, you can find a solution to allowing your credit card to stay open and still avoid an annual fee.
Here are the final take-a-ways:
- Try to avoid cancelling credit cards by exploring other options.
- Remember that while cancelling a credit card may not immediately hurt your credit score, the longer you keep your accounts open, the less damage opening up new accounts will do to your score since your AAOA will be longer. Also, the longer your accounts remain open, the more payment history you can build.
- If you have to cancel a card, focus on keeping your utilization as low as possible and to try to keep your oldest accounts open as long as possible.
- You can often mitigate the damage done by opening new accounts by going after small business credit cards.