How Cancelling Your Credit Card Can Affect Your Credit Score (Instead Of Helping It)
Closing or cancelling your credit card can negatively impact your credit score. There are several pros and cons you need to consider before doing it. Read this article to learn when to cancel your credit card and how you can do it the right way.
You may have an old credit card that you don’t use anymore, or you could have signed up for way too many credit cards just because of the freebie that came with them. But in reality, you could be only using one main credit card for all your transactions.
As a knee-jerk reaction, you call your banks to cancel the other credit cards that are seemingly of no use to you anymore. Besides, it’s kinda like spring cleaning your finances, isn’t it?
Except for the fact that… it isn’t. Cancelling or closing a credit card can actually have a serious impact on your financial health, and we’ll explain in just a second.
Does closing a credit card hurt your credit score?
There are multiple pros and cons of closing a credit card, but just to level with you, we’ll tell you that closing a credit card will easily tank your credit score – and that’s the biggest disadvantage you’ll get when you cancel your card. Before we explain how that works, allow us to first explain what ‘credit score’ means for the benefit of those who aren’t aware.
What’s a credit score? In a nutshell, it is a number between 300-850 which represents your creditworthiness and how likely you are to repay debt. These are the three most important digits of your life. Banks, companies, money lenders, investors, and even some potential mothers-in-law will check your credit score before deciding whether or not to have anything to do with you.
A good credit score shows that you’re trustworthy when it comes to money, so it’ll be easy for you to get financing help when you need it. Likewise, a poor credit score will raise red flags and have institutions turn away from you.
Your credit score is determined by 5 factors:
- Payment History (45%) – whether you pay your loans on time or have missed payments in the past
- Amount Owed (20%) – the number of credit facilities and the amount owed to the banks
- Credit History Length (7%) – the amount of time you held a credit facility (credit card, or a loan)
- Credit Mix (14%) – the types of loans and credit cards you hold – secured (home, car loans) vs unsecured credit (credit cards, personal loans)
- New Credit (14%) – any approved new credit facilities in recent times
So, how does cancelling a credit card affect your credit score? If you see the five points above, your payment history makes up a big chunk of your score (45%). Adding to that, 7% goes to your credit history length.
If you’re closing a card with a good payment history, you’re also completely deleting all that sweet, sweet record that banks love to see. You also can’t get back that payment history, since you can’t go back in time. The only way to get it back is to simply… build it up again from scratch.
By cancelling a credit card, you’ll also increase your credit utilisation ratio. The lower your utilisation ratio, the better for your credit score. See, let’s say you have five cards, each one with an RM5,000 credit limit. In total, all five cards give you a combined credit limit of RM25,000. However, you typically only charge RM5,000 to your default credit card in a month.
If you get rid of three credit cards that you rarely touch, you’ll drop your total credit limit while maintaining the amount you typically use in a month. Percentage-wise, don’t you think that would cause a massive spike to your utilisation ratio?
|With 5 credit cards (total credit limit RM25,000)||With 2 credit cards (total credit limit RM10,000)|
|Credit utilisation ratio with RM5,000 monthly usage|
(RM5,000 ÷ RM25,000)% = 20%
|(RM5,000 ÷ RM10,000)% = 50%|
|Verdict||Lower credit utilisation, looks healthier to banks!||Higher credit utilisation, looks riskier to banks!|
As you can see, you can reap highly valuable benefits just by keeping your cards active. If you’re convinced enough to keep your cards, you may also want to try making a few purchases in a year just to keep the card alive (but remember to pay them off immediately). This helps the bank see that your account is still active, and avoid having them surprise you by closing your account.
What other options do you have other than to cancel your credit card?
First thing’s first: figure out your options.
You can try to work out a special deal with your bank. Just dial them on your phone and tell them about your intention to close a card. See, the last thing your bank wants is for you to close your credit card. In cases like this, they may give you a retention offer so you’ll put the scissors back in the drawer.
A retention offer could come in the form of a point incentive or a discount on the annual fee. We’ve heard from many people that they managed to waive their annual fee just by talking to their bank – this writer included.
And if they won’t give you what you want, you can always ask them about your options to downgrade your card (also known as ‘product change’). You could be trying to get rid of your incredibly exclusive platinum card with an RM500 annual fee. That very bank may have an entry-level card with zero annual fees – why not opt to change to that instead, and never worry about any unpaid annual fees.
So… when to cancel a credit card?
The only time you should consider cancelling your credit card is:
1. When you can’t control your spending
If you’re spiralling into debt and can’t find a way to control your spending, there’s no question in cancelling your credit card. The whole argument of keeping your card is to help maintain a good credit score, but if you’re already in debt, you’re already ruining your credit score. Keeping a credit card at this point could only entice you to spend more, and in no time you could find your debt size multiplying significantly.
Remember, credit cards come with a pretty high interest fee (15% to 18%), so you should always strive to clear off all your balances when you get your bill!
2. When the annual fee is too high and there is no way of downgrading
If the bank won’t budge, if the annual fee is exorbitant – might as well cancel the card to have a peace of mind.
How to close credit cards the right way
If you’ve weighed your options and are still keen on cancelling your credit card, remember to sort this out with the bank in a systematic way:
1. Check your outstanding balance and pay it off.
Don’t leave a single cent unpaid, and take into account the pending due amount that you may have spent before the current billing date. To play it safe, check with your bank on any outstanding balance in the next two months too – just in case you miss out on anything. The last thing you want is to leave an outstanding balance and forget about it!
2. Redeem all your points/miles/cashback first.
You can never get back your rewards if you cancel your card. Check with your bank on what you can redeem, and try to use every single point you’ve accumulated over the time you’ve had the card. If you’re using a cashback card, request your bank to send you a cheque for the remaining cashback you’re yet to receive.
3. Ensure no subscriptions are tied to the card.
It’s common to forget that you have subscriptions. Check your previous statements to trace back your subscriptions, and change them to the credit card you want to keep. If you miss this step, you can expect unwanted interruptions in whichever service you signed up for.
4. Keep everything in black and white, and save it in a secure place.
Just to be safe, save your records and email them to yourself (e.g. requesting for a card cancellation, paying off your outstanding payments). You may or may not need this in the event your cancellation request doesn’t go through.