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It’s no surprise that travel rewards credit cards get quite a bit of coverage here at TPG. Taking advantage of top sign-up bonuses and strategically using your cards for everyday purchases can unlock fantastic redemptions like premium-class flights and luxurious hotel rooms. However, there are a number of misconceptions out there when it comes to credit cards, so today I’ll continue our new series that debunks these myths and allow you to begin planning for your next vacation. The first entry covered having too many cards, and today I’ll move on to another hot topic.
Myth #2: Closing a card I don’t use will help my credit score.
There are many reasons why you might have a credit card that you simply don’t use anymore. It may have been the very first one you opened as an adult that has since been replaced with a more valuable card, or you may no longer have a use for that particular currency earned on a card. You may think that you should cancel an unused card sitting in your wallet (or desk drawer) to help you credit score, but the reality is the exact opposite.
For this series, it’s essential to understand the different factors that contribute to your FICO score, the one most frequently used to determine your creditworthiness for any new line of credit:
- Payment history
- Amounts owed
- Length of credit history
- New credit
- Types of credit used
However, not all factors are created equal, and these five are weighted based on how important they are to your score:
When it comes to closing a card you no longer use, there’s one primary factor that can impact your score in a negative way: amounts owed.
Amounts Owed
The second most important factor in your FICO score is the amounts owed, commonly referred to as your credit utilization rate. This looks at how much of your credit you are actually using and is typically expressed as a percentage. Here’s the calculation:
Keeping this number low shows issuers that you can effectively manage your credit lines and aren’t at risk of overextending yourself.
Let’s say that you typically spend about $2,000 per month on your primary credit card with a $10,000 limit, and you currently have another unused card, also with a $10,000 limit. You thus have a utilization rate of 10% ($2,000 / $20,000). However, if you then cancel that unused card, the monthly spending is now spread across a much lower overall credit line. By canceling the card, your utilization jumps to 20%. That number isn’t too concerning, but anything that impacts your score shouldn’t be taken lightly.
Of course, that’s not to say that you shouldn’t ever cancel a credit card. If you’re no longer using a card that carries an annual fee, it may not make sense to keep that card open, unless the benefits you’re getting outweigh the fee. Just be sure to call the issuer and inquire about a retention bonus. The agent may even be willing to wave the annual fee.
Length of Credit History
While the amounts owed is the primary factor that will be impacted by canceling a card you no longer use, it can also impact your credit history, which makes up 15% of your credit score. If the unused card is your longest tenured account, canceling it can negatively affect the average age of your accounts, which is why I always recommend opening and keeping at least one card with no annual fee. Just be sure to make a least a few purchases a year on the card to prevent the issuer from canceling it due to inactivity. This can also help prevent your points and miles from expiring.
For some additional tips on how to successfully manage your credit cards, be sure to check out my post on Ten Commandments for Travel Rewards Credit Cards.
Bottom Line
There are many myths about credit cards out there, and one common misconception is that you should cancel a card that you don’t use anymore. In reality, this can have a significant impact on your credit score, as it will lower your overall credit limit and thus increase your utilization rate while also (potentially) decreasing your average age of accounts. While there may be legitimate reasons to cancel a card, don’t do it without first considering how it will affect your credit score.
For additional information on your credit score and credit cards, check out the following posts:
Source: thepointsguy.com