Should You Close Unused Credit Cards?

If you have not used one of your credit cards for quite some time, the thought of closing it must have crossed your mind. However, when it comes to personal finance, the seemingly practical option may not always be the right one. Cancelling a credit card may hurt your credit score which is why many experts suggest leaving unused credit cards open. However, this does not mean that you should never cancel your cards. Let us understand how an unused credit card impacts your credit profile.

How closing a credit card impacts your credit score?

Your credit score is generally affected by these 5 major factors- new credit, outstanding amount, credit mix, credit utilisation and the length of your credit history. Among these, your unused credit card directly impacts the credit history or age and credit utilisation.

Credit History

While determining your credit history, the credit bureaus not only consider your oldest and the newest credit card or loan accounts, but also the average age of all your other loan accounts combined. A longer credit history is usually preferred as the lenders would be more willing to lend to a person who knows the rules of the credit market than to someone who has recently stepped into this arena. So, closing the older unused credit card accounts can decrease the length of your credit history and even lower your credit score.

Credit Utilisation 

This is calculated in the form of the ratio of your debt that you are currently using to your total available credit. This debt-to-credit ratio includes the data from all your loan accounts, along with the individual credit utilisation on different credit cards. Financial experts advise users to maintain their credit utilisation ratio (CUR) low at all times for which the unused credit cards help you. Closing any of your credit cards can lower the total available credit, thus increasing this ratio.

As discussed above, unused credit cards have a direct impact on credit utilisation ratio and the length of credit history. If you have owned a credit card for quite some time, say two to three years, closing it may not be a wise decision. However, if you have had the card for just a few months, closing it will not have a significant impact on your credit score. Moreover, an unused credit card also keeps a considerable credit limit locked-in, improving the credit utilisation ratio which, in turn, improves your credit score. Let us understand this with the help of an example given below.

Suppose, Rahul has three credit cards with the following limits-

• Credit Card 1- Rs. 1,00,000
• Credit Card 2- Rs. 2,50,000
• Credit Card 3- Rs. 80,000

He is thinking of closing Credit Card 1 as he seldom uses it but has to pay a hefty annual fee. The total debts on Rahul currently amount to Rs. 1,10,000.

So, closing credit card 1 will make Rahul’s credit utilisation ratio shoot up above the usual reasonable limit of 30% which might result in a decline in his credit score.

When is it a good idea to close your unused credit cards?

Though it is generally advised not to close your credit card, there are a few situations under which it might make more sense to discontinue a card, such as-

• When the credit card does not offer you any kind of perks.
• When the annual fee on the credit card is too high.
• When you have too many credit card accounts.

If your credit card poses a combination of the first two challenges- it attracts huge annual fee but does not provide benefits that suit your needs- then it may be a good idea to go ahead with credit card discontinuation. Also, you should not have too many loan accounts open at the same time as lenders find such people credit hungry.

Surprisingly, sometimes closing a credit card can also result in an increase in your credit score. This may happen when you have several cards from the same bank and you request them to close a card and transfer its limit to another card. In this case, the credit utilization ratio on one card will come down, thus improving your credit score. Another great way to achieve this is by closing a credit card held for a short duration. This way you can improve the average age of your accounts.

The Bottom Line

Closing a credit card is not recommended but when done strategically it may not come as a regret. It makes sense only when you are required to pay hefty annual fee without getting any benefits whatsoever. Do not just stop using a credit card completely. Rather you should try to understand the rewards and benefits on these cards so that the same can be maximized.

Before closing a credit card account, you must take a closer look at its pros and cons, the types of benefits that it offers and how much harm could be done to your credit score if you close it. The decision will vary from card to card, so you should invest some time into it.