In the last year, literature in personal finance focused a lot on financial defense like canceling a credit card. There was a lot of talk about credit, credit reports, and your credit score because it’s one of the cornerstones of the modern financial life, whether you like it or not. During that time, many card issuers started canceling cards, reducing credit limits, and otherwise reducing their overall financial risk. Rampant foreclosures and sinking home prices, issuers were scared and started cutting people based on where they shopped!
Now that the economy has recovered, many people don’t want to be in the position they were a year ago – feeling like the card issuers held them and their credit score hostage. The easiest way to do this is to reduce how much credit you use and the quickest way to do that is to cancel credit cards.
How do you cancel a credit card without significantly hurting your credit score?
Don’t Do It
If you are planning on buying a home or car (or otherwise need a loan) in the next year, avoid any changes to your credit unless it’s fixing an existing problem. If you aren’t planning on a large loan in the next year or two, a little financial housekeeping might be in order. You won’t help your score by canceling cards but you could simplify your financial situation and that always helps.
Paying Down Debt
The first step in any credit card reduction strategy is to reduce your outstanding debt. The main reason why canceling a credit card is bad for your credit has to do with credit utilization . Credit utilization is your outstanding balance divided by your total credit limit across all debts. A higher number means you’re using more of your existing credit, which is a bad thing. Canceling cards is bad because it decreases your total credit limit, thus increasing your utilization without increasing your risk (all you did was cancel a card).
Don’t cancel a card that has a balance. If you do, the debt becomes due immediately and you may find yourself in a difficult spot trying to pay it off. Don’t let the issuer know that you plan on canceling the card after paying off the debt because they might boost the interest rate on you (under the auspices of “risk”).
If you have little or no outstanding debt, then your credit utilization number can’t go up significantly.
Cancel Newer Cards First
The second reason why canceling a card hurts your score has to do with the average age of your accounts. This is less important than credit utilization but if you have a choice, cancel the newer cards first. If you have two cards to choose from and the newer one offers better rewards you will use, then cancel the older one. You want to pick the card that fits your needs, you don’t want the credit score industry to do it for you.
If you aren’t sure which card is newer, you can review your credit report  to find out how old an account is.
Convert or Consolidate Cards
If you have two cards from the same issuer, consider consolidating credit lines . Ask to have the newer line consolidating into the older line. This, in effect, cancels the newer card but does not affect your credit utilization because your total credit limit remains the same. This is the best result you can have out of canceling a card because you keep the total credit line and you increase the average age of your accounts.
Likewise, if you prefer the newer card’s rewards, consolidate the credit limits and then ask to have the old card converted to the newer one. This can get a little tricky because you want a conversion that doesn’t require a credit check (which hurts your score) and you don’t want a new account. If you request this, be clear with the CSR that you don’t want them to cancel your old card and open a new one, you just want a conversion. Some issuers will do this, others won’t.
Call to Cancel
When you cancel your card, be sure to ask the credit card company to report the closure as “Closed at the customer’s request” and to send you written confirmation. You’ll need to confirm in about 30 days, when the closure is reported, on your credit report and retain the letter in case there is a dispute. You don’t want the report to say “Closed by creditor” because that looks bad.
Canceling a credit card account can be tricky but as you’ve just read, there are only a few moving parts to keep an eye on. In the end, you need to do what makes sense for you and I’ve laid out all the potential land mines along the way. We’ve been trying to simplify our finances for the last year, consolidating cards, canceling bank accounts, and otherwise just keeping our books a little smaller. In that time, I’ve learned that there may be a lot of pitfalls but they’re easy to navigate.
(Photo: thetruthabout )