Many of us have that unused credit card that sits in the back of our wallets. Now be honest. Have you ever been tempted to cancel it? After all, doesn't cleaning up old credit make sense in theory? It is a common misconception that canceling an old credit card helps your FICO score. In reality, the opposite is true. Closing an old card can have a detrimental impact! And here's why.
Does Canceling A Credit Card Hurt Your FICO Score?
A Quick Refresher
To summarize, your FICO score is influenced by five factors. Each of them carries a different level of importance when calculating your score. I covered these in more detail in The Ultimate Guide to Understanding Your FICO Score. However, here is a quick refresher:
- Payment History - 35% of your score
- Amount Owed (Utilization) - 30% of your score
- Length of Credit History - 15% of your score
- New Credit Inquiries - 10% of your score
- Types of Credit - 10% of your score
Canceling a credit card primarily impacts your Amount Owed (Utilization), which contributes to a whopping 30% of your FICO score. However, it also affects your Length of Credit History, though to a lesser degree.
Primary Impact: Amount Owed (Utilization)
One of the most important contributors to your FICO score is the amount you owe across your credit cards as a percentage of your total credit limit. This metric is called your "credit utilization." Let's say I have a Nordstrom credit card with a $5,000 credit limit. I never use this card, so it carries no balance. In this instance, the Nordstrom card helps my utilization. It increases my total credit limit without increasing the amount I owe. A larger denominator makes my utilization ratio smaller. And you thought you were done with algebra!
Let's walk through a simple example. Let's assume I have three credit cards: Nordstrom, Chase, and Discover. Each card carries a $5,000 credit limit. I carry $0 on Nordstrom, $2,500 on Chase, and $2,000 on Discover. This is how I calculate my utilization:
Total Balance Across All Cards / Total Credit Limit
($0 Nordstrom + $2,500 Chase + $2,000 Discover) / ($5,000 Nordstrom + $5,000 Chase + $5,000 Discover)
($4,500) / ($15,000)
The typical guidance is to keep your utilization below 25-30%. This shows credit issuers that you can responsibly use your credit lines without overextending yourself. In this example, I'm currently in that sweet spot! But what if I canceled my Nordstrom card? Let's look at the impact to my utilization:
($2,500 Chase + $2,000 Discover) / ($5,000 Chase + $5,000 Discover)
($4,500) / ($10,000)
Because my credit limit decreased by $5,000 when I canceled the card, my utilization spiked from 30% to 45%. That's a big deal, especially since utilization is the second largest component of my FICO score! Unless the Nordstrom card charges me a high annual fee, I probably shouldn't cancel it.
You might be thinking: couldn't I just open a new credit card to replace the old credit limit? The answer is yes. However, keeping the unused card can still only help your utilization. For more information on opening new credit cards (retail cards in particular), check out last week's post: Should You Open That Retail Store Credit Card?
Secondary Impact: Length of Credit History
In addition to your utilization, closing a credit card impacts the length of your credit history. This contributes to 15% of your FICO score. A longer history is good, as it gives lenders more insight into your borrowing and repaying habits. But here's a fact that not many people realize: Old credit cards stay on your credit report for 10 years, provided there is no negative data associated with them. So if I close my Nordstrom card today, it won't actually decrease my average age for another 10 years. Still, if this was my oldest credit card, it probably makes sense to keep it.
A Few Pro Tips
When your card charges you a fee: The only reason I would condone canceling a card is if it charges an annual fee and you do not earn rewards to offset it. But before you cancel, call the issuer. In many cases, they'll waive the annual fee for a year or offer a reward bonus! You know when you call your cable provider and speak to 3 people before they connect you with the "retention specialist"? This is the same thing.
If you do decide to cancel: Make sure you redeem all of your outstanding rewards! You may forfeit these points and miles as soon as you cancel the card. Additionally, if you use this card to pay any bills automatically, make sure you transfer those payments. Trust me, this will save you a big headache down the road.
If you decide to keep an old card open: An issuer may close your account after a period of time with no activity. If you have an old card in your wallet that you want to keep, make sure you use it periodically to keep it active.
The Bottom Line
Many people believe that canceling an old credit card helps their FICO score. This is simply not true! There is no harm in keeping an old card on your books. In fact, it helps you. An old credit card lowers your utilization by keeping your credit limit high and also increases the average age of your accounts. So, unless the card charges you a fee, keep it in your wallet. And make some small purchases on it every once in a while to keep it active.
I'd love to know, how old is your oldest credit card?