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Credit Card Cancellations Usually Affect Credit Scores

by Indexcreditcards Indexcreditcards
Credit Card Cancellations Usually Affect Credit Scores

Credit Card Companies Asking for Cancellations

With their recent imposition of higher credit card rates and new annual fees–not to mention inactivity fees–it feels as if some card issuers are actively encouraging their customers to cancel accounts. Certainly, large numbers of consumers resent being asked to pay for something that was previously offered free and are asking themselves whether they need so many cards.

But before cutting up any plastic, you should think twice. Because closing a card account may well adversely affect your credit reports.

Credit Score Calculations

Your FICO credit score–the one that most lenders use–is calculated using five criteria, and the importance of each is represented by the percentage weighting shown in the following list:

  1. Your payment history (35 percent)–mostly affected by late payments
  2. How much you owe (30 percent)–most importantly, the difference between the amount you’re currently borrowing and your available credit
  3. Length of your credit history (15 percent)–generally speaking, the longer your credit history, the higher your score
  4. New credit (10 percent)–your score is likely to suffer if your credit report shows multiple recent applications for new credit
  5. Other factors (10 percent)–a whole list of these, including whether your mix of credit types (mortgage, auto loan, credit cards) is healthy

Credit Scores and the Cancelling of Credit Cards

The reason your FICO score might suffer if you cancel a credit card is associated with the second factor in that list. The relationship between your available credit and the amount you actually owe is called your “utilization ratio.” When you reduce your available credit by closing an account (and so losing that card’s limit), you’re likely to increase that ratio and potentially harm your score.

Of course, if your use of credit is already low, then the effect is likely to be minimal. But if you transfer balances, the impact could be more damaging.

One expert gave yesterday’s Washington Post an example. Suppose someone closed card accounts in a way that increased their utilization ratio from seven percent to 85 percent. If that person’s credit score had previously been in the 800s, it could end up in the low 700s, or even in the high 600s, solely as a result of the ratio rise.

Credit Scores Matter

The U.S. General Services Administration’s website explains the impact that a poor credit score can have on all borrowers. This particular scenario shows the effect on a couple who are buying their first home:

Let’s say they want a thirty-year mortgage loan and their FICO credit scores are 720. They could qualify for a mortgage with a low 5.5 percent interest rate. But if their scores are 580, they probably would pay 8.5 percent or more–that’s at least 3 full percentage points more in interest. On a $100,000 mortgage loan, that 3 point difference will cost them $2,400 dollars a year, adding up to $72,000 dollars more over the loan’s 30-year lifetime.

Of course, interest rates (and property prices) have changed since that example was written. But the point remains valid. And that is–credit reports matter.

Disclaimer:The information in this article is believed to be accurate as of the date it was written. Please keep in mind that credit card offers change frequently. Therefore, we cannot guarantee the accuracy of the information in this article. Reasonable efforts are made to maintain accurate information. See the online credit card application for full terms and conditions on offers and rewards. Please verify all terms and conditions of any credit card prior to applying.

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