Connect with us

Money Saving

6 Reasons Why You Shouldn’t Cancel Your Credit Card

Published

on


Credit cards can be very useful tools. They often offer cash back, travel rewards, or other benefits. 

Additionally, many people use credit cards as a financial tool to get through tight times. Unfortunately, this can get people in financial trouble.

At some point, the idea may have crossed your mind that it’s time to close your credit card account. Maybe you don’t ever use your card anymore. Or perhaps the card charges an annual fee you don’t want to pay anymore.

While there are plenty of good reasons to cancel a credit card, such as preventing yourself from going deeper into debt, closing a credit card can have negative consequences, too. 

Here are six considerations to think about before you decide to close your credit card.

Closing a card could hurt your credit

6 Shocking Reasons You Shouldn’t Cancel Your Credit Card - Closing a card could hurt your credit

Did you know closing a credit card or another loan could actually hurt your credit score? I’ve had it happen to me. You may be better off keeping your credit card open if you need your credit score in tiptop shape.

If you’re about to take out a big loan, such as a mortgage or car loan, having a higher credit score could result in getting a lower interest rate. This could end up being a big difference if you’re right on the edge of a credit tier. 

For instance, if you need a 760 credit score to get the best interest rates and you currently have a 762 credit score, closing a credit card could knock you below the top tier rates. This could result in paying more interest over the life of your loan.

But just how big of a deal is this? Let’s say you’re taking out a 30-year $300,000 mortgage. If you fall into the top credit score category, your rate is 4%. If you miss out and fall into the next tier, your rate will be 4.125%. 

Over the life of the 30-year mortgage, that 0.125% rate difference results in paying almost $8,000 more. That’s a huge difference for such a small rate change.

How closing your credit card could hurt your credit score

So now that you understand how a drop in your credit score can impact you, why does closing a credit card hurt your credit score? In reality, it won’t always hurt you. Credit scores take many different factors into account. When you cancel a credit card account, some of those factors change.

Exactly how much your credit score changes and whether it goes up or down will depend on your particular situation. Here are the major changes that could happen from closing your credit card and how they could impact you.

Amounts owed

According to the FICO scoring models, the amounts owed part of your credit score makes up roughly 30% of your score. This includes factors such as how much debt you owe overall, on different types of accounts, and many other factors.

One key factor of this portion of your score is your credit utilization. This is the amount you owe on your revolving accounts, such as credit cards, compared to your credit limits.

Let’s say you have two credit cards. One has a $5,000 balance and a $10,000 credit limit. The other has a $0 balance and a $40,000 credit limit.

Across all of your credit cards, your credit utilization ratio is 10% ($5,000 / $50,000). However, if you close your high credit limit credit card that you don’t use, your credit utilization ratio will shoot up to 50% ($5,000 / $10,000). This could result in a big drop in your credit score.

Length of credit history

Your length of credit history accounts for a smaller 15% portion of your FICO credit scores. This considers how long your accounts have been open on average, as well as the history length of your oldest account and other factors.

If your first credit card didn’t offer any rewards, you might not use it often anymore. Closing this account would get rid of your oldest credit card account and could significantly decrease the average age of your credit accounts.

For this reason, closing old accounts could negatively impact your credit score. Think carefully before you shut down one of your oldest accounts.

Credit mix

In some cases, closing a credit card could hurt the credit mix part of your credit score, too. Credit mix makes up approximately 10% of your score and focuses on your ability to pay back different types of debt. 

If you only have one revolving credit account, your credit card, and you close it, you no longer have an account open with one of the main types of credit. This could negatively impact your credit score. 

Avoid closing your oldest or only credit card

Based on the above explanations, there is one credit card you should avoid closing if at all possible. That’s your oldest or your only credit card. Your oldest credit card could actually be your longest credit account on your file. 

By closing this, you could end up dramatically shortening your length of credit history and you may lose your oldest account at the same time. While the length of credit history only accounts for about 15% of your credit score, maximizing each part of your score is important. 

Here are 3 scenarios:

  • If your oldest card doesn’t have an annual fee and you aren’t tempted to run up debt on it, keep it open. Throw it in a drawer and make a charge on it a couple of times each year to keep it active. Then, pay it off in full. 
  • If your oldest credit card charges an annual fee, it probably doesn’t make sense to keep it open unless you’re about to take out a significant loan. Your score will eventually recover and you’ll save money at the same time.
  • If your oldest credit card is also your only credit card, you could hurt your score even more. By not having revolving credit, you could impact your account mix portion of your credit score. That said, keeping a credit card open to help your credit score isn’t worth it if you’re going to continue racking up debt and paying crazy interest charges.

The benefits the card offers often outweigh the costs of the card

Today, many credit cards offer benefits that make them well worth their cost. While I don’t believe you should ever pay interest on a balance to get a credit card benefit, I do think paying an annual fee on certain credit cards can be smart.

Common benefits could include free hotel stays, rewards on purchases that exceed the annual fee you pay, free travel credits, and more. You’ll have to run the numbers to make sure the benefits you get actually exceed the cost of the annual fee. If they do, consider keeping the card even though you have to pay for it.

For instance, I have a hotel credit card that charges me a $49 annual fee each year. When I pay that fee, I get a free night at one of their hotels. That free night can easily be redeemed for a stay that would otherwise cost me $100 or more. 

Since I know I’m going to need to use at least one hotel night per year, keeping that card makes sense even if I don’t use it. If I simply canceled it because I haven’t used it to make purchases lately, I’d miss out on that free night benefit that saves me money.

Your rewards balance could disappear

6 Shocking Reasons You Shouldn’t Cancel Your Credit Card - Your rewards balance could disappear

If you’re a natural saver like I am, it’s easy to let your credit card rewards balance grow. Sadly, canceling a credit card almost always results in your credit card rewards disappearing. 

Some issuers may give you 30 days or some other time frame to redeem your points after your account is closed. Others invalidate your rewards immediately.

For most people, it doesn’t make sense to cancel a credit card you have a significant points balance on. You can usually transfer the points out, use them for a redemption option, or keep the card open.

Apply Now

I’ve kept a Chase Sapphire Preferred® Card open, which charges an annual fee, because my points are worth more when I use them to book travel. I get a 25% larger redemption value by doing so. I could cash out my points for cash back, but I’d lose that 25% bonus.

This boosted value more than pays the annual fee cost of the card, so I keep it open. I also get value from the card in other ways, but this is one example of when it doesn’t make sense to shut down a card with a large points balance.

You might end up missing payments that charge to the credit card regularly

One way to wreck your credit is by making late payments that are reported to credit bureaus. If you use your credit card to make automatic payments toward expenses that could get reported to the credit bureaus, be very careful before closing that credit card.

When you close your account, automatic charges will no longer go through. If you used your card to make payments on a medical debt payment plan and don’t change your payment method, your medical debt could end up going to collections.

You don’t have to keep a credit card open to continue paying automatic payments. You can switch the automatic payment to a different card. Even so, this can be a hassle. If the card doesn’t charge an annual fee and you’re getting rid of it for convenience, it may be even more convenient to keep the card.

You could lose access to credit you could need in the future

6 Shocking Reasons You Shouldn’t Cancel Your Credit Card - You could lose access to credit you could need in the future

When you cancel a credit card, you lose access to the line of credit it offers. No one has a crystal ball that can see the future. If you shut down your credit cards and later need the line of credit, you may not be able to get approved for a new credit card right away.

Credit card companies aren’t likely to approve you for their cards if you recently lost your job. Those same companies probably won’t find out immediately that you lost your income, either. That means you could continue using already available credit cards as a last-ditch effort to cover your necessary expenses.

I don’t like using credit cards as an emergency fund. They can put food on the table when you have no other money or options, though. For this reason, I don’t mind leaving a credit card open as long as I know I won’t be tempted to go into unnecessary debt by doing so.

You could be making money with a referral program

Certain credit cards allow you to refer your friends to sign up for the card. My Chase Sapphire Preferred® Card allows this. For each referral, I get bonus points added to my account. The credit card offers great value, so I usually get a couple of friends to sign up each year.

If you have a credit card that offers excellent value and a referral program, you may want to keep it open as I do with my Chase Sapphire Preferred® Card. The referral bonuses I get more than cover the annual fee cost and I get to use the extra points for fun trips or other uses.

If I closed my Chase Sapphire Preferred® Card, I could still refer my friends to get it. I just wouldn’t benefit at all. This, along with the travel bonus mentioned earlier, make keeping this card open an easy decision for me.

Learn more about the Chase Sapphire Preferred® Card here.

Options other than closing your credit card

6 Shocking Reasons You Shouldn’t Cancel Your Credit Card - Options other than closing your credit card

If you have a credit card with an annual fee but no longer want to pay the fee, you don’t necessarily have to cancel the account.

Downgrade your credit card

Some credit card issuers will allow you to downgrade your credit card to a no annual fee version. This can help you keep your line of credit and your account history while avoiding a costly annual fee.

Decide not to use your credit card – no matter what

Those that are tempted to spend on a credit card but want to keep the credit history can try some tricks to avoid this. You could literally freeze your credit card in a block of ice in your freezer so you can’t make purchases with the card. 

This assumes you don’t have the card number memorized and you can talk yourself out of making an impulse purchase while you wait for the ice to melt. You could also ask someone to keep the card from you, but you have to trust they won’t make unauthorized purchases with your card. 

Summary

If you know these tricks wouldn’t work for you, sometimes canceling your credit card is your only option. While your credit score may take a hit, you could end up saving much more money than a slightly higher credit score could help you.

But a lot of the time, it just doesn’t make sense to cancel a credit card. Between the potential damage to your credit score, the loss of benefits, and other reasons, you could be better off putting that card in the freezer. 

Ultimately, the decision is yours to make. You know yourself best. Do what is right for you.

Read more:





Source link

Continue Reading
Advertisement