When Canceling a Credit Card, Use Caution – Money Perception

Closing a credit card account you rarely or never use might seem like a no-brainer. But if you’re not careful, doing so could lower your credit score and raise the rate you might have to pay for a home mortgage, a car loan, or other loans you apply for in the near future. Here’s what to keep in mind when thinking of canceling a credit card account.

You’re planning to apply for a mortgage or other loan. Your credit score is based partly on your credit utilization ratio, or the amount of available credit that you’re using. (To figure yours, divide your credit card balances by your total credit limits and multiply by 100.) The lower your credit utilization ratio, the better. When you close an account, you lose its available credit and your credit utilization ratio goes up. Though each lender has its own policy, they generally prefer to see a credit utilization rate less than 30 percent, and the lower, the better.

It’s your only credit card. Having a mix of credit types (credit cards, installment loans, store cards, etc.) has a positive impact on your credit score (accounting for 10 percent of your overall score). If you have only one line in the credit card category, closing the card will reduce your mix of credit types and have a negative impact on your credit score.

The right card combos can save you hundreds of dollars per year. Read: How to Cash In on Cash-Back Credit Cards.

It has an annual fee. Keeping an account that you never plan to use and that charges an annual fee is a waste of money, unless one of the aforementioned situations applies.

You haven’t had it that long. Because your credit history—the length of time you’ve had a credit account or loan—has a positive impact on your credit score, pick the card you opened most recently if you’re choosing among cards to close.

You won’t be applying for new credit soon. Your credit score will take a brief hit after you close an account, but if no other changes occur, it should rebound after about six months.