What happens when you close a credit card

Many people know that opening a credit card is easy, but what happens when you close a credit card? The short answer is, not much. However, it can impact your credit score, payment, history, and the rewards you earn. That’s why you need to ensure you’re prepared before you cancel your credit card.

Does closing a credit card affect my credit score?

Closing your credit card may impact your credit score in a variety of ways. While the impact may be minimal, there are some situations where it could greatly affect your credit score. Here’s why.

One consideration for your credit score is your credit utilization ratio. That’s the amount of credit you’re using relative to how much credit you have available. In most cases, the credit bureaus want to see your credit utilization ratio below 30%. If you were to close a credit card, you may unintentionally increase your utilization ratio.

For example, let’s say you have two credit cards. Each one has a limit of $5,000 ($10,000 combined limit), and you regularly charge $2,500 to your card. Based on this, you’d have a credit utilization ratio of 25%, which is a good number. However, let’s say you decide to cancel one of these cards. Your credit utilization ratio would now be 50%, which is well above the recommended utilization ratio of 30%. This could result in your credit score dropping.

Another consideration for Equifax and TransUnion - the two credit bureaus - is your credit history. The credit bureaus want to see you using your credit for an extended period of time. If you were to close your oldest credit card, you’d lose all of that history.

Generally speaking, when you close a credit card, you’ll likely see a small decline to your credit score. However, if you have other credit cards and a low utilization ratio, your credit score will increase over time.

When you should close a credit card

Since closing a credit card may impact your credit card, you won’t want to cancel them without a specific reason. Here are some situations where closing a credit card makes sense:

• You no longer use the card: Unless it’s your oldest credit card, there’s no real reason to hang onto credit cards you never use.

• High annual fee: Many premium credit cards come with a high annual fee. If you’re paying a fee each year and getting limited benefits, it’s likely a good time to cancel your card.

• You want different rewards: There are credit cards that earn travel, cash back, or store rewards. If you no longer like the rewards you’re getting, then you should cancel your card and get a new one,

• The interest rate is high: Most credit cards in Canada charge an interest rate of 20% to 24%. Paying your balance, and cancelling your card could help you manage your finances.

• You’re worried about your spending: Credit cards can give you increased buying power, but they may also encourage you to spend more. With limited access to credit, you could keep your budget under control.

• You want more benefits: Every credit card is different, and some come with better benefits than others. If you’re interested in perks such as airport lounge access, mobile device insurance, travel insurance, and more, you could cancel your current credit card and get a new one.

When you should keep a credit card open

While there’s no denying that closing your credit card can make sense in many situations, there are some times when it makes sense to hang onto your card:

• It’s your oldest credit card: Since the length of your credit history determines part of your credit score, it would be beneficial to keep your oldest credit card.

• You have no other credit cards: Having access to credit also helps determine your credit score. Keeping at least one credit card open is essential.

• It gives you access to credit: Even if you don’t use your credit card much, having access to credit can be helpful. You can use it when making large purchases, booking travel online, and more.

• You have unclaimed rewards: With some credit cards, you’ll lose all of your rewards earned once you cancel your card. You may want to cash in your rewards before closing out your account.

• It gives you benefits that you value: Even if you don’t use your credit card for purchases regularly, some of the benefits you get, such as travel insurance and roadside assistance, may be enough for you to keep the card.

What to do when closing a credit card

If you’ve decided to cancel your credit card, there are still a few things you need to do to ensure you close your credit card in good standing:

1. Cancel any pre-authorized payments that are charged to your cards, such as gym memberships and entertainment subscriptions.

2. Redeem any outstanding rewards, so you don’t lose them.

3. Pay off any outstanding balance.

4. Contact customer service and ask them to close your account. Get a reference number before hanging up.

5. Wait for the written confirmation to arrive in the mail. Hang onto that letter just in case anything happens.

6. Destroy your old credit card.

Alternatives to closing your credit card

Even though there are many reasons to close or keep your credit cards open, there are a few alternatives that may address your needs:

• Product switch: Some credit card providers will allow you to switch your current credit card to another one. This will not affect your credit score, but it also gives you an opportunity to switch to a new credit card that’s more suited for you. That could be a no fee card or one that comes with additional benefits.

• Ask for a lower credit limit: In many cases, people want to cancel their credit cards to restrict how much access to credit they have. Instead of cancelling your card, you could just ask for a lower credit limit.

• Get a prepaid card: If you’re worried about your spending, you could get a prepaid card such as KOHO. Since you can only spend what you’ve loaded to your card, you’ll never go into debt. Plus, KOHO has a credit building option that allows you to build your credit score.

The bottom line

Closing a credit card can lower your credit score, but if you still have access to credit and you always pay your bills on time, your credit score will likely increase again after a few months. That said, hanging onto your oldest credit card can often be worth it just to maintain a healthy and long credit history.