In most cases, canceling a credit card won't help your credit score. In fact, it may actually hurt your score. You see, your credit score depends on how you shake out in five different credit-scoring categories, each weighted differently when calculating that score:
According to Evan Hendricks, author of the book Credit Scores and Credit Reports, canceling a credit card potentially can hurt you in at least two of the five categories and maybe even a third.
What counts in a credit score?
This chart shows how Fair Isaac Corporation values the various parts of your credit management to determine your credit score. Source: Fair Isaac Corp.
Credit-utilization ratio is key
First, canceling a card could upset your credit-utilization ratio, the second most heavily weighted category in Fair Isaac's credit scoring algorithms. For example, assume you have three cards with total available credit of $20,000. Assume further that your outstanding balances total no more than $6,000 of that available credit at any one time. Since creditors like to see a credit-utilization ratio of 30 percent to 35 percent or less, you're in good shape. Now, assume that you cancel a card with a zero balance and a $10,000 credit limit. Suddenly, your utilization ratio jumps to 60 percent and your credit score drops.
As counter-intuitive as that seems, that could happen. Impersonal credit-scoring systems aren't concerned so much with how much available credit you have but with how you manage that credit. And in the credit-scoring world, a 30 percent utilization rate is much better than a 60 percent one. "That's what scoring models want to see, a good utilization rate," Hendricks says.
Furthermore, he says, canceling that card could result in a double whammy to your credit score "because each card is scored individually, and then all your cards are scored together. (If) you've just canceled the card with a zero balance, (you've) lost a great individual score." Regardless, if you still want to cancel a card, he says, "make sure to pay down your other balances to keep that rate in line."
Most common reasons consumers are denied credit
- serious delinquency
- serious delinquency and public record or collection filed
- time since delinquency is too recent or unknown
- level of delinquency on accounts is too high
- amount owed on accounts is too high
- ratio of balances to credit limits on revolving accounts is too high
- length of time accounts have been established is too short
- too many accounts with balances
One of the reason codes (reason number 4) tells you if having too many cards has hurt your score. Common sense should tell you that the older you are and the better you manage your credit, the more cards you can have in your wallet before you reach the magic number that triggers the reason code (though you may be surprised to learn that 10 or more cards is not too high in some cases). "In any event, if you're in that rare category and have plenty of credit and low balances on the other cards, canceling a card may help you," Hendricks continues.
Though canceling a card probably will not increase your credit score, holding on to one has a number of advantages. For one, Fair Isaac and VantageScore look for a healthy credit mix, a mix that might include a mortgage loan, a car loan, maybe a store card or two, three or four MasterCard or Visa cards and a home equity line of credit, or HELOC, for example.
HELOC effect
Of course, it's not simply a matter of having diverse sources of credit. They also want to see responsible credit usage on your part, including credit card balances in the healthy 30 percent to 35 percent range. "That's a sign of an active and responsible credit person," Burns says. "On the other hand, if somebody consolidates their credit cards or revolving credit down to just a handful of credit sources and has high utilization rate, that will be detrimental to their score."
And this is where credit-score math gets fuzzy. Many consumers have consolidated outstanding credit card balances into a HELOC, both for the lower rate and because they thought doing so might help their credit scores. (For what it's worth, Fair Isaac's Watts wonders whether mortgage brokers, in an effort to generate more loans, first pitched the myth that canceling a credit card would help your score.) Once again, the answer is "it depends."
"Home equity lines of credit are really interesting creatures when it comes to credit scores," Watts says.
What's interesting is that it may make sense to consolidate credit card balances into a HELOC because Fair Isaac may treat the new HELOC as an installment loan rather than a revolving loan. However, Watts points out that with Fair Isaac, that only happens if the HELOC is a large line of credit. Small HELOCs are regarded as revolving lines of credit, much like your credit cards. Thus, as with credit cards, it might help your credit score in some cases to close out a HELOC. "But in all cases, paying down a real estate-based loan like a mortgage or a HELOC is going to help your score," says Watts.
And that seems to be the key to the kingdom when it comes to credit cards and credit scores: Don't cancel your cards. Pay them off. And after you've done that, don't send them back. Cut them up. Do that, and you have a zero balance enhancing your credit utilization rate. Do that, and you maintain your credit history on open accounts. Do that, and your credit mix looks good. Do that, and you still have the available credit on the card you cut up. All you have to do is ask for a new card when you need it.
Nevertheless, if you have a compulsion to cancel credit cards, do it the right way. First, cancel your department store cards; then cancel the newest MasterCard or Visa with the lowest credit limit, making sure to close the card from the company that doesn't report credit limits. "And make sure to keep your credit-utilization ratio in line as you cancel, paying down balances on your other cards, if necessary, to keep it in line," says Hendricks. Score one for the consumer.
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