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How to Minimize the Impact of Canceling A Credit Card

With the passing of the CARD Act [3], credit card companies have been responding by instituting purchase-based annual fees [4]. Before the CARD Act, many issuers were trimming their books of inactive, low-activity, and risky credit card accounts. You may remember American Express offering cardholders a financial incentive to close accounts [5].

In this environment, there may come a time when you will want to cancel a credit card. A few years ago, canceling a credit card was easy. You called them and told them you wanted to cancel, they try to keep you around, you did that dance, and then diced up your card. Nowadays, you go through the same charade, but now you have to be worried about how the cancellation would impact your credit score! Boo!

So here are some tips on minimizing the impact of canceling any one credit card.

Use a Debit Card

Bottom line: You don’t have to use credit cards. I think credit cards are better than debit cards [6] but banks don’t charge you annual fees for debit cards. By using a debit card, you are in total control. You won’t owe anyone money and you won’t pay interest. On the flip side, you won’t be building credit but there are plenty of other ways to build credit. By sticking with a debit card, you never have to worry about the impact of canceling a credit card.

Use a Credit Union Credit Card

The problem with the large corporate credit card issuers is that they have millions of customers and they have stockholders to keep happy. Credit unions, and local banks, usually don’t. With credit unions, the customers are the owners and so you often get favorable rates and treatment with a credit union card. The benefit of this is that you get to build credit and you probably won’t see a nasty surprise letter informing you of huge rate hikes, excessive fees, or unexpected cancellations.

Have & Use Several Credit Cards

Throughout the entire financial crisis, I never once received a message from Discover stating they were lowering a credit line, canceling a card, or requiring an annual fee. I’m not saying Discover is immune from the financial crisis, far from it, but if you have several cards then the canceling of any one of them will have only a minimal effect.

The reason your score goes down when you cancel a card is because your credit utilization will go up and the average age of your revolving accounts will (likely) go down. Credit utilization refers to how much of your total credit limit you are currently using. By actively using several credit cards, you can benefit from incremental credit line increases (such as with Citi where you can request no-credit-inquiry credit line increases [7]), which will reduce the pain of canceling any one card.

Request Credit Line Increases

This goes hand in hand with the second tip of using several cards. Take advantage of credit line increases whenever you an. You can ask Citi for one and they may grant it to you without a credit inquiry, which is a good thing. With other issuers you may have to call and ask for an increase, but confirm that they don’t do a hard credit inquiry prior to approving you because hard inquiries will damage your score.

Don’t Cancel The Card

If you want to minimize the impact of canceling a card and you have a choice, don’t cancel it. In the case where the issuer is instituting an annual fee, try to get the card converted to one without that fee. Try to roll the credit limit on the card to another card you have that is issued by that company.

In the end, canceling a credit card isn’t the end of the world. When I played with Credit Karma’s credit score simulator [8] and pretended to close my oldest credit card, my TransUnion credit score of 731 didn’t change. If you’re a year away from getting a car loan or a mortgage, I wouldn’t worry too much about the penalty. If you’re a month away, keep the card until after you get the loan, then let it be canceled because by then your score will matter less.

(Photo: baptistefranchina [9])