Does cancelling a credit card you haven't used in a while lower your credit rating?

So let’s discuss how the simple act of canceling a credit card can reduce your credit score. You’d think that canceling a credit card would be one less account on your record, right? Well, the problem is that a card cancellation negatively affects three of the five credit factors that I mentioned.

The biggest issue is something called “credit utilization”. You’d think that canceling a credit card would be one less account on your record, right? Well, the problem is that a card cancellation negatively affects three of the five credit factors that I mentioned.

Credit utilization comes into play with the second factor--the number of credit accounts you have and how much you owe on them. Your credit utilization is expressed as a ratio of your credit balances to your available credit limits; it’s also called a debt to credit ratio. Let me give you an example.

If you have a credit card with a $4,000 credit limit and your balance is $1,000, you’re using 25% of your available credit. To calculate your credit utilization for any credit account, simply divide your current balance by the credit limit. For my example, the calculation is $1,000 divided by $4,000, which equals 0.25 or 25%.

There’s no specific ratio that FICO or the credit bureaus recommend, but the lower you keep your credit utilization ratio, the better. Many experts propose that you use 30% or less of your available credit to optimize your credit score. Any time your available credit limit is reduced, it increases your utilization ratio, which can negatively affect your credit score.

So canceling a card--even one that’s paid-off--leaves you with less available credit. That increases your utilization ratio and causes your credit score to drop. An important quick and dirty tip is to never max out all your available credit lines, even if you pay off your balance in full each month.

It’s better to have two credit cards that each have balances below 30% of your credit limits than to have one card that you consistently max out. Keeping a good cushion of available credit can raise your credit score. Another issue to consider before you cancel a credit card is how long you’ve had it.

Your credit history is the third most important factor in the calculation of your credit score. Canceling a long-standing credit card shortens your history, which could be an additional injury to your credit score. The last reason I’ll give you not to cancel a credit card is that you need a healthy mix of credit accounts.

As I mentioned, that makes up 10% of your credit score. If you cancel your only credit card, that would leave you deficient in the revolving credit category. It’s important that you weigh the pros and cons of canceling a credit card for yourself.

I certainly discourage you from having a credit card if you wouldn’t use it wisely. If you can tuck it away and use it only for emergencies, that’s great. But if the temptation to use it would still be there, one solution is to keep the account open for the sake of your credit score, but to shred the card.

What Affects Your Credit Score the Most? I would love it if you took a moment to connect with me on Facebook and Twitter. You can get more tips and bonus content, submit a question or comment, or just be a part of the Money Girl community.

I’m glad you’re listening. Chi-Ching, that's all for now, courtesy of Money Girl, your guide to a richer life.