Will Canceling a Credit Card Hurt My Credit Score?

Q: I dread the thought of credit card companies assessing an annual inactivity fee if you don't use their card. Over the years, I've accumulated several cards -- many from the 1970s when I was newly married. We wanted to establish credit, and card solicitations seemed to arrive in the mail daily.  I knew the billing dates for each card, so I could stagger the payments over the month, and sometimes get more than 30 days to pay a bill.  I always paid off all cards in full, and I still do.

If I choose to cancel a card because of a new annual fee, will that lower my credit rating?  I am divorced and retired now, and I'm concerned about my credit rating especially when I need to buy a new car. --BA via email

A: You handle your credit cards extremely well, but you're right to be concerned.

The cancellation of an unused card can hurt your credit score, whether the card is canceled by you or by the credit issuer. (In case you didn't know, the credit issuer has the right to cancel a card you don't use.)

Some credit issuers are indeed reintroducing inactivity fees on their cards. If yours are among them, you have three choices: 1) pay an inactivity fee for cards you don't use; 2) cancel those cards and risk hurting your credit score; or 3) avoid inactivity fees by using all your cards, thus increasing the risk of adding to your outstanding debt.

Talk about a stacked deck!

It isn't impossible to rid yourself of an unwanted card and emerge relatively unscathed, but it takes careful advance planning.

Let's start by explaining why canceling a card can hurt your credit score. (For those who don't know, this is a three-digit number ranging from 300 to 850 that lenders use to assess how good a credit risk you are. The lower your score, the harder it is for you to get a loan and the more you'll pay for it.)

Your credit score is based on your past use of credit. The most important factor in this history is whether or not you pay bills on time. That accounts for 35% of your score.

The second most important factor, accounting for 30% of your score, is how much of your available credit you actually use. Lenders call this your utilization ratio. If your total available credit is $5,000, for example, and your average outstanding balance is $1,250, you have a 25% ratio. If you have a $3,750 balance, you have a 75% ratio.

The more of your available credit you use -- the higher your ratio -- the worse it is for your credit score. A good ratio is 30% or less. If you're maxed out on your cards, you're considered a bad risk.

When you cancel an inactive card, you automatically increase your credit utilization ratio. Let's say you have five cards, but only use two. Your total available credit on the five cards is $10,000; your outstanding balance on the two you use is $2,500. Your ratio is therefore 25% ($2,500 divided by $10,000). But perhaps when you cancel the three cards you don't use, your total available credit limit drops to $5,000. Your ratio automatically jumps to 50% ($2,500 divided by $5,000).

And that's not the only damage. The length of your credit history -- how long you've had your oldest card, and the average age of all your lines of credit --  accounts for about 15% of your credit score. The longer your history, the better your score. You say you've had some of your credit cards since the 1970s. If you cancel cards you've had for 40 years and keep cards acquired more recently, you'll erase that long track record. A much shorter credit history means a lower credit score.

So what's the solution?

First, don't cancel any of your cards if you know you'll soon be looking for a car loan or a mortgage! That might lower your credit score, driving up the cost of borrowing.

For the time being, avoid inactivity fees -- and card cancellations by issuers -- by using all your cards. Make small purchases that you pay for in full every month. You're good at juggling cards, but for most people who have a lot of cards this advice isn't easy to follow. If you have 12 cards, making sure you use each one every month and pay all the balances on time can soon become a bookkeeping nightmare.

Second, after you get your car loan, plan your card cancellations very carefully to minimize the damage to your credit score. Think of yourself as David mapping out a campaign against Goliath.

Make a master list of the inception dates and credit limits on each of your cards, bearing in mind that the most important cards to keep are the oldest and those with the highest limits. 

Before you cancel a card, take steps to lower your utilization ratio. You can do that by temporarily reducing your average outstanding balance and/or by getting a higher credit limit on one of the cards you intend to keep. If you lower your ratio before canceling a card, the cancellation may only push it back up to where it was before.

Remember, too, that credit scores are constantly updated. So even if your score takes a dip after you cancel a card, it can recover before you need to apply for another loan.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.(c) Lynn Brenner, All Rights Reserved

Comments

[James Cottongim]

A lowered or low credit score may affect much more than loan rates for autos, etc. My insurance company will, with the approval of the insured, check my credit and lower my premium if my score meets their criteria. In my case, I saved about $200 just by have a good credit score.

[Betty Atwell]

Just rec'd notice from Citi of the new annual fee of $60 year for the privilege of possessing their card. They will refund the $60 after you spend $2400 on it. I sure can't afford to spend $2400 on each credit card I own (and there are a lot), but I don't want to damage my credit score if I cancel any cards.

They've got us over a barrel. I also can't afford to pay the annual fee for all the cards I have. The credit monitoring firms need to show when we cancel one of these cards that it was because we refused to pay the new annual fee and it should not negatively impact our credit score. A vendor told me the card companies have raised their fees to them from 3% to 5% (Amex to 7%) so they'll still make millions on that! Of course, it will get passed on to us as higher prices so we're getting hit twice.