Will Closing a Credit Card Improve Credit Score?
There’s no definitive answer to this question because canceling a credit card will affect credit score in more than one way and the impact could be either positive or negative.
To see what I meant, let’s first take a look at how a FICO score is determined. Obviously, there’s no way we can know what kind of formula is used in the FICO score calculation. But with the help from FICO, we do know what elements contribute to one’s FICO credit score and how much each element weighs in the overall calculation.
How FICO Credit Score Is Determined
Following is a breakdown of a FICO score (PDF file) from FICO.
As you can see from the above chart, two dominant factors in your credit score are payment history and amounts owed on all credits. Payment histrory referrs to the track record of past payment information of all your credit accounts, not just credit card accounts, but also store credit accounts, installment loan accounts and mortgage accounts. Since 35% of your credit score is determined by payment history, it’s always good to have a clean, long history of on-time payments in order to have and maintain a good credit score.
The second element in the list, the amounts owed which accounts for 30% of your credit score, is more about the credit utilization ratio than the absolute amounts owed. Having $100,000 overall credit limit and using only $10,000 is totally different from having $10,000 limit and using all of them. In both cases, the absolute amount owed is the same at $10,000, but only 10% of the available credit is used in the former (thus the credit utilization ratio is 10%) while 100% is used in the latter. Generally, the lower the ratio the better.
Length of credit history mesures how long your credit history has been established, which started when you obtained your first credit, whether it was a credit card, store card, or a loan. The length of credit history usually includes the oldest credit and the average age of all your credit accounts. The longer the credit history the higher the score.
New credit makes up about 10% of the overall credit score, which takes into consideration not only the number of new credit accounts, but also the time period those new accounts were obtained. The number of new credits you own (and the number of recent credit inquires) and the time since the newest account usually serve as an indication of whether or not you are taking new debt. The fewer new account the better.
Finally, the types of credit you are using also affects your FICO score, though not as greatly as other factors mentioned above. Ideally, you would want to have a good mix of different credit accounts including both credit cards (revolving credit) and loans (installment credit) to show that you have experience with different types of credit.
Will Cancelling a Credit Card Improve My Score?
Now that we know how a FICO score is determined, let’s see what could happen if you cancel a credit card. From the above discussion, the biggest impact cancelling a credit card could have is on the amounts owed because it changes the overall credit utilization ratio, especially when the card has a big credit limit. In this case, the amounts owed won’t change but the total available credit will be reduced, leading to an increase in the ratio, which could me a drop in your score. If, on the other hand, the cancelled card only has a very small limit, your score still won’t improve, but any drop in score could be very small.
Generally, cancelling a credit card will also change the length of your credit history. If the card you plan to cancel happens to be your oldest card, you may want to think twice before closing it because that could dramatically shorten the average age of your credit accounts, which will be negative to your score. But it’s a different story if it’s a new card (for example, those you opened just to get the incentive). To see what I mean, assume you own four cards with the age of 5, 4, 3, and 1. The average age of all your account is 3.25 years. Now if you cancle the newest card (age 1), the average age improves to 4 years, which means your score could get a boost, though may be very little. But if you close the oldest (age 5) instead, the average reduces to 2.67 years. This is definitely not what you want.
Since a late payment record will stay on your credit report for 7 years, closing the credit card that has the late payment will not improve your score. Also, unless the credit card is the only credit card you own, cancelling it won’t have any significant impact on the mix of your credit. However since FICO score does look at the total number of accounts you own, closing an account, thus reducing the total number of accounts, could be positive to your score.
There were a few times in the past when I cancelled some credit cards that I no longer wanted. Because of the concern about credit length, what I did was, instead of calling the issuer and telling them to close the account, I always asked them to move the credit limit from the card that I wanted to cancel to another account that I have with the same issuer. In this way, I kept the overall credit limit, thus the credit utilization ratio, intact while reducing the total number of accounts I own.
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