To Cancel or Not to Cancel Credit Cards

With all of the information out there about credit scoring, it's hard to know if cancelling credit cards will be good or bad for your credit health. It might seem like a no-brainer to close out credit cards that you haven't used in years, but the truth is, it's usually better to keep them open.

First of all, you should know that just because you cancel a credit card does not mean it drops from your credit report. A closed account will stay on your report for years to come. So cancelling a credit card with a negative history is hardly like waving a magic wand to make it disappear. Only time can do that.

So if credit card accounts remain on your report whether you cancel them or not, what’s the harm in cancelling them? Two answers: Length of credit history and a little term called utilization.

Length of Credit History

The key to a strong credit score is to build up a nice, long history of good credit. Lenders love a consumer with a lengthy proven track record of paying down debt in a timely manner. So it makes sense to keep that first credit card you got as a college freshman back in 1982, especially if the account is in good standing. By keeping the card, even if you never use it, your credit history spans almost three decades. And since length of credit history accounts for 15% of your credit score, that Banana Republic card you opened in 2006 just can’t compare.

Utilization

The other reason to keep credit cards open is to maintain a healthy credit utilization rate (otherwise known as your debt-to-credit ratio). Basically, the idea here is that it's better to have more credit available to you than less. Credit bureaus tend to drop your credit score if you're using too much of your available credit.

Example: Say I have three credit cards with different credit limits of $8,000, $10,000, and $15,000. I never use the first two, but I routinely have a balance of around $7,000 on the third.  This means I'm utilizing 21% of my total credit ($7,000 divided by my total credit limit of $33,000). If I were to cancel the two cards I don't use, then my utilization rate jumps to 47%, which in turn would lower my credit score. (Note that credit bureaus look at both the total utilization rate as well as the utilization rate of each card, so I'd be better served to keep my balance lower on the card with the $15,000 limit, and let one of my other cards pick up the slack.)

While the credit bureaus aren't forthcoming with their precise scoring formulas, we do know that lower utilization rates will significantly boost your score.

Still Want to Cancel?

If you've already got a low utilization rate (say, under 30%) and are still itching to cancel some of your cards, here are the guidelines you should follow:

• Never cancel a credit card with a balance. You should always pay off your account in full before closing it.
• Cancel younger cards before the older ones. As discussed above, you want to keep the cards with the good, long histories.
• Cancel the cards that charge annual fees or have really high interest rates.
• Cancel the cards that don't report credit limits. When a credit card company doesn't report your credit limit, the bureaus think you're using 100% of your available credit on that card (which drops your utilization rate). To find out who reports limits, either ask the credit card company directly or just check your credit report.
• Cancel cards if their open lines of credit are tempting you to spend. It may ding your score a bit, but that’s better than acquiring debt you're unable to pay down.

Once you've made the decision to cancel a credit card, make sure you do it the right way. Call the credit card company; don't just cut up the card. And make sure they give you a written confirmation for your records.

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