How Important Is Maintaining My Credit Utilization Ratio?

TPG reader Richard sent me a message on Facebook to ask about managing his credit score:

To see how this works, suppose you have 10 cards that each have a credit line of $10,000 (for a total limit of $100,000). If your cumulative balance across those accounts is $5,000, then your utilization ratio is 5%. Canceling a card reduces your total credit limit (the denominator in the utilization ratio), but whether that has a meaningful impact depends on how many other accounts you have open and how much you use them.

Closing three cards in the example above would reduce your total limit from $100,000 to $70,000, increasing your utilization ratio from 5% to about 7%. That small increase isn’t likely to matter in the long run. On the other hand, if you started out with only four cards instead of ten, then canceling three of them would drop your total limit from $40,000 to $10,000. In turn, your utilization ratio would increase from 12.5% to 50%, which would almost certainly have a negative impact on your credit score.

There’s no universal answer here, but avoiding a high utilization ratio is certainly worthwhile. If you can close an account and maintain a ratio of less than 15%, then I wouldn’t worry too much about it. If closing an account pushes your ratio to around 15%-25%, then you should consider other options like downgrading your card to a no-fee version or replacing the old account with a new one as Richard suggested. I would be reluctant to close an account if doing so left me with a utilization ratio of more than 30%.

If you decide to swap your current accounts for other cards with no annual fee, I recommend that you apply for the new card before canceling the old one. That way, your existing credit line will still be factored into your score, so your utilization ratio will remain high while your application is being considered. Of course, new applications also impact your credit score, so be sure to take all the different factors into account.

For more info about when to cancel a credit card, check out these posts:

If you have any other questions, please tweet me @thepointsguy, message me on Facebook or send me an email at info@thepointsguy.com.

Source: thepointsguy.com