So, you’ve been on a mission to clean up your credit and reorder your finances, and you’ve reached a point where you’re debating whether to close those credit cards with zero balances you’ll no longer use. The question is whether you keep them open or chop them up and shut them down. More importantly, how does each decision impact your credit health moving forward? As with many questions in life, the answer is that it all depends. Before discussing the pros and cons of each option, it is important first to gain a general understanding of credit, how it works, and how your credit report measures it.
Credit Reports Demystified
A credit report is a general history of your dealings with credit. There are three credit reports—one from each of the three national credit reporting agencies: Experian, Equifax, and TransUnion. These three national credit reporting agencies collect information from lenders who report it. For example, if you have a credit card, your card’s issuer likely reports your account activity to one or more of these three agencies once a month. This culmination of your credit history information is a numerical representation, known as a credit score or FICO® score, which provides you and potential lenders with a snapshot of your overall credit health. This score is based on five different factors with varying degrees of impact. They are the following, listed in the order of impact on your FICO® score:
- Payment history (35 percent): The most important factor in determining your overall credit score. It accounts for your ability to make on-time payments and avoid delinquency or collections on your accounts. The more positive and consistent your payment history, the better your score.
- Amount owed (30 percent): The second most important factor in determining your overall credit score. It accounts for the total amount you owe, your credit utilization ratio, the percentage of available credit you use on each credit card, and across all your credit card accounts. The lower your credit card balances relative to their limits, the better it is for your credit score.
- Length of credit history (15 percent): This accounts for how long you’ve been using credit in general and the average age of all your accounts. As a result, it is impacted by the opening of new credit lines, so avoiding any unnecessary borrowing and use of credit over time can have positive effects.
- Credit mix (10 percent): This credit scoring factor considers the different types of credit accounts you have, such as credit cards, student loans, mortgage loans, auto loans, and more. In general, though, your credit mix doesn’t affect your score much unless your credit report doesn’t have much other information to use to calculate your score.
- New credit (10 percent): Every time you apply for credit and a creditor runs a hard inquiry on your report—an evaluation of your creditworthiness—it hurts your credit score. If you apply for multiple credit accounts in a short period, it could be a red flag to potential lenders.
Should You Open That New Card?
Now that we have a general understanding of what a credit score is and how it is calculated, let’s review the pros and cons of a decision to open or close a credit card. Are there any benefits? The answer remains the same: it depends. Based on the scoring factors we previously discussed, opening a new credit card can positively affect your overall credit mix. This is especially true when you’ve never had such an account type in your credit mix. Lenders generally like to see your ability to handle different types of credit responsibly.
On the other hand, this action could also decrease the length of your average credit history, hurting your score. It can also increase the number of new credit inquiries on your report, another potential negative for your score. Thus, the best approach is to limit the number of new inquiries or applications for credit while diversifying your credit mix.
When to Call It a Day and Close That Card
So then, what about closing a credit card? The good news here is that the answer is less ambiguous. If we consider the closing of a credit card as it relates to the previously discussed credit scoring methods, it should be immediately clear that there will be a negative impact on the average age of your credit history, which accounts for 15 percent of your overall score. This is especially true for older lines of credit. Another potentially negative impact that can result is an increase in your credit utilization ratio in situations where you carry any other credit card balances. Of course, this does not necessarily mean there are no pros to closing a credit card account. Other factors to consider include no longer paying annual fees for a credit card you no longer use or avoiding the temptation to run up additional balances.
In the end, the decision to open or close a credit card will require you to consider the specifics of your situation. If a card doesn’t cost you money, such as annual fees, and you’re confident it’s not going to tempt you to get in over your head and into financial trouble, there’s little harm and actually a benefit in keeping it open. If a credit card is one of your oldest cards, you may want to reconsider closing it. Keeping it open can help your credit score in the long run.