Why Closing a Credit Card Could HURT Your Credit Score

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Should you close an unused credit card?

0:29 - How credit score is calculated
1:15 - Credit utilization explained
4:05 - Length of credit history explained

Your credit score is calculated based on five different factors. Two of those factors are directly affected by your unused credit cards, and those are:l ength of credit history and credit utilization ratio.

Length of credit history is basically how long you've been using credit cards, and it makes up 15% of your FICO score. More specifically, it's influenced by the age of your oldest account (the older the better), the age of your newest account (again, older is better), and the average age of all your accounts combined.

This is why it's smart to leave unused credit cards open, especially if you've had them for a while. According to Experian -- one of the major credit reporting agencies -- "Closing an account with a long positive history may not always be the best action to take for your credit scores."

Credit utilization ratio is even more important. It's the portion of your available credit you're currently using, and it's responsible for 30% of your FICO score. It takes into account your overall debt-to-credit ratio across all accounts and your individual credit card balances as compared to their limits. Credit-scoring company VantageScore recommends keeping these ratios below 30%, but the lower, the better.

Unused credit cards boost your credit score by lowering your credit utilization ratio. Let's look at an example of a person's hypothetical credit utilization ratio before and after closing a credit card with a $5,000 limit.
Say you have $20,000 in available credit and you generally use about $5,000. That would give you a credit utilization ratio of 25%.

Now if you closed that card, your available credit would dip to $15,000 and if your spending stays the same your utilization would be 33%.
As you can see, closing that unused credit card would bring your credit utilization ratio above the 30% threshold and likely cause a decrease in your credit score.

When you should close unused credit cards
Your credit utilization ratio and length of credit history are the reasons why it's often best to keep unused credit cards open. However, there are some circumstances in which closing an unused credit card might not hurt your score -- and may even raise it.

If the credit card in question is a newer credit card or your newest credit card, then closing it is unlikely to have a negative impact on your length of credit history. If it has a low credit limit, or if you don't have much debt, then it shouldn't have much of an impact on your credit utilization ratio either.
Even if closing a credit card does increase your credit utilization ratio, this number is updated continually. So if you plan to pay off your debt in the next few months, you'll see that rate go right back down.

How closing an unused credit card can increase your credit score

If you have multiple credit cards with the same issuer, they may allow you to transfer your credit balance from a closed card over to your remaining card.
Say you hold four credit cards with a single card issuer, but you close one of them because it has an annual fee. That credit card has an $8,000 credit limit, and you ask your card company to transfer that credit limit to one of your other cards, and they're happy to do so. This means that even though you're closing a credit card with an $8,000 credit limit, your available credit remains the same.

In fact, you could even see a slight bump in your credit score for two reasons:

Your credit utilization ratio on an individual credit card may go down. Imagine you're closing a credit card and transferring its $8,000 limit to another card that has a $5,000 limit and a $2,000 balance. Thanks to that limit increase, the credit utilization ratio of that card will drop from 40% to 25%. Remember, while your overall credit utilization ratio is important, so is your credit utilization on each individual account.

My length of credit history went up. The average age of all your accounts is a major factor in calculating the length of your credit history, and the credit card you close may be your newest one.

If you're strategic about it, closing an unused credit card can help your credit score, rather than hurt it.

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Видео Why Closing a Credit Card Could HURT Your Credit Score канала The Motley Fool