Over the years, you may have accumulated several credit cards ranging from traditional ones to those issued by gasoline companies and department stores. Some of those cards may hardly be used since you only opened those accounts for the original discounts. Now, you are thinking about closing the accounts for a few cards. Before you do this, act with caution.
Understanding your credit utilization ratio
This ratio measures your total credit balance across all cards divided by the total credit limit. For instance, if you have a $3,000 credit card balance on a Visa with a limit of $5,000; a $2,000 balance on a MasterCard with a limit of $10,000, then your credit utilization ratio would be $3,000 + $2,000 divided by $5,000 + $10,000 or $5,000/15,000=33.33%.
Closing a credit card account reduces your total limit
In the above example, let’s suppose that you want to close your Visa account which has a balance of $2,000 and a limit of $5,000. By doing so, your overall balance doesn’t change but your credit limit or the denominator would decrease. Specifically, it would go from $15,000 to $10,000 and thus your credit utilization ratio would go from $5,000/$15,000 or 33.3% to $5,000/$10,000 or 50%. Lenders and the credit bureaus may identify a higher credit utilization with a borrower that is closer to maxing out their credit cards across accounts. This should be avoided since your credit utilization ratio accounts for ~30% of your credit score.
It is also important to understand that closing a credit card account doesn’t mean that your balance goes away too. The balance remains on your credit card account until it is paid off.
Increase the credit limit on another card before closing an old card
There is a way to avoid being penalized for closing an old credit card account. Increase the limit on another card before you close the old card which will prevent an increase to your credit utilization ratio and thus a hit to your credit score.
More credit card questions? Browse answers or ask your personal finance questions online.
Related Articles
->When Should I File For Bankruptcy?
->Will My Credit Be Impacted If My Business Files For Bankruptcy?
->Will I Be Taxed If My Credit Card Debt Is Discharged?
->How Can I Improve My Credit Score?
->How Will A Short Sale Impact My Credit Score And Tax Liability?
->What You Need to Know When Checking Your Credit Score
->Will my Credit be Impacted if I’m Late on a Credit Card Payment?
