Closing a credit card once you’ve paid it off might seem like the right decision, particularly if you’ve carried debt beyond your comfort level. Even if you’ve recently paid off a high-revolving balance, it may not be the best strategy, especially if you are trying to improve your credit score as a business owner.
Instead of making a quick judgement call that could impact your credit, it’s best to figure out if closing a credit card is the right decision or not.
Questions to ask before closing a credit card.
Will you spend beyond your comfort level again?
Make sure to examine the behaviors that got you into debt in the first place to avoid it happening again.
Are you worried about identity/card theft?
While this is a possibility, as of September 21 you will be able to freeze your credit for free, regardless of the state you live in. Since creditors have to access your credit history in order to open accounts in your name, a credit freezes can make it harder for identity thieves to affect you financially. You can then easily remove it if you’re applying for a mortgage, loan, or new credit card.
Is there an annual fee?
If there is, it might make sense to cancel it, especially if you don’t intend to use the credit card again. Keep in mind, even if you close your credit card with a zero balance, it will likely remain on your credit report for seven to 10 years.
As long as there isn’t an annual fee, many experts recommend cutting up the credit card or even freezing a card in a block of ice so it can only be used for emergencies. Then delete the credit card information from any online stores like Amazon.com, Target.com and other retailers so it can’t be easily accessed or used.
How long have you had the credit card?
Credit history matters. The longer you’ve had your credit card, the more reporting credit bureaus tend to like it.
How your credit score may be impacted
Closing a credit card may hurt your credit score since it reduces the amount of your total available credit. Credit bureaus look at the ratio of how much you owe on a credit card compared to your credit limits. Most credit bureaus consider any credit card debt over 30 percent of your limit to be a high balance.
Here’s an example of how credit card utilization works. Let’s say you have $25,000 in credit available on four credit cards. You have cards that have $10,000, $7,500, $5,000 and $2,500 limits. If you have $5,000 in credit card debt among all four cards then you’re using 20 percent of your total credit card utilization.
If you decided to close the credit card with $10,000 credit limit on it, even if you aren’t using the card and are carrying a zero balance, then your total credit card utilization jumps to 33 percent.
Besides looking at your total credit card utilization among all accounts, creditors will also look to see how much credit you are using on each individual credit card compared to the available credit. This is known as your per-credit card utilization.
For example, if you have a credit card limit of $10,000, to stay at or below that 30 percent threshold you shouldn’t charge — or utilize — more than $3,000 a month on that card. Keep in mind, even if you charge more and pay off the balance each month, depending on when the credit bureaus report, it could still impact your credit score. This is one reason why some people pay off their charges before the bill is due, to keep their per-credit card utilization below that 30 percent threshold at any time. Creditors often see you as a more creditworthy borrower if you stay below that amount.
Closing a credit card and credit utilization ratio
When you close a credit card, it increases your total credit utilization ratio — meaning you have to carry lower balances, even if you pay off the bill each month, to stay below the 30 percent limit.
Keeping a credit card account open, even if you don’t intend to use it, may help to improve your credit score by lowering your credit card utilization ratio. If you’re not comfortable keeping a credit card open, you can always close one card and request a credit limit increase for another card to help maintain a lower credit card utilization ratio.