Does closing a credit card hurt your credit score?

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Learning about credit scores

Your credit score is based on your payment history, credit utilization ratio, credit history length, credit types, and recent inquiries. Of these, the credit utilization ratio—the amount of available credit you are using—contributes a great deal. Closing a card will impact this ratio and the average account age, which in turn affects your credit score.

Impact on credit utilization ratio

When you close a credit card, available credit decreases but debt remains unchanged. This increases your utilization ratio. You have two cards with Rs.1 lakh limits and are using Rs.50,000. Your ratio is 25 percent. If you close one of the cards, available credit decreases to Rs.1 lakh and the ratio increases to 50 percent. Your greater ratio indicates greater risk to lenders and can decrease your credit score.

Effect on the length of credit history

Your credit age accounts for about 15 percent of your credit score. Closing an old account might reduce your credit history length, especially if the account was one of your initial cards. Although the account is closed, the account history can remain within your credit report for seven years. Eventually, the closure will reduce your account-average age and that might negatively affect your score.

Other potential effects

Closing a credit card also affects your credit mix, one of the considerations used to calculate your score. Lenders prefer borrowers who have a varied mix of credit accounts, including credit cards, loans, and other forms of credit products. Closing a credit card might reduce your credit mix if you lack a plethora of other accounts.

Closing a credit card when it's appropriate

Even with the potential effect, there are circumstances where card closing is reasonable. If a card possesses a high annual fee that surpasses benefits, or if having several cards in check is bothersome; closing it shields your finances. Before closing, make payments on balances and make sure other cards within your portfolio have a low usage rate.

Tips to safeguard your credit score

If you do close one, it is best to transfer the balance to other cards so that utilization is low. You can also call and request an increase in your other credit cards' limits so that the lost limit is replaced. Keep track of your credit report at all times so that you notice how change affects your score and repair them if needed.

Closing a credit card won't destroy your credit score, but closing a credit card without thinking can have unforeseen consequences. Understanding this and taking care can help you navigate the process without harming your finances.