By Tom Gilmour, CFP®
This post originally appeared on LearnVest.
In our “Ask a CFP” Q&A series, we cede the floor to a Certified Financial Planner™, who will address some of the trickiest money topics out there.
Today, Tom Gilmour, a CFP® with LearnVest Planning Services, discusses whether it’s ever wise to cancel a credit card.
“When it comes to financial health, your credit score is one of the most important stats out there—those three digits affect everything from how much interest you’ll pay on a loan to whether you’ll qualify for a new apartment.
But there’s a lot of confusion about which factors really affect your good credit standing—particularly when it comes to keeping card accounts open.
So this naturally leaves a lot of people wondering: Should you ever close a credit card?
If running from the collection agencies isn't your exercise of choice, read this book for tips and tricks on how to crush credit card debt.
Why So Many People Ask This Question The most common reason clients give for wanting to close a credit card? They’ve finally paid off their debt, and they think that doing so will help them avoid future temptation.
But while those are good intentions, the truth is that hastily closing a newly zeroed-out account can actually undo your financial progress.
What I Tell Them For your FICO score’s sake, it’s a good rule of thumb to leave credit cards open—especially your long-standing accounts.
That’s because credit history is an important component of what informs your score, and shutting down old accounts will shorten the length of your record—and potentially cause your score to dip.
And that’s just one consequence.
Closing a card could also increase your credit-utilization ratio. This factor—which makes up 30% of your FICO score—measures how much of your total available credit you’re currently using.
Say you have two credit cards with a $1,000 limit on each one, and a $500 balance on one card. Your current credit utilization rate is 25%. That’s a healthy amount, since it’s generally recommended that you stay below 30%.
But if you decide to close the card with no balance, your credit-utilization ratio suddenly soars from 25% to 50%—a leap that could significantly drop your score.
There’s typically just one time when I reverse my stance on this topic: If the card in question carries a high annual fee, your budget may benefit from shutting it down. But, again, make sure it’s not your oldest card, and that doing so wouldn’t send your utilization ratio into dangerously high territory.
Bottom Line In most cases it’s best to keep all of your credit cards active.
But if you’re still tempted to close one to curb your spending habits, try this instead: Take a pair of scissors, and snip the physical card so you can’t use it—but leave the account open!”
RELATED: My Quest for the Perfect Credit Score
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc., that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment, legal or tax planning advice. Please consult a financial adviser, attorney or tax specialist for advice specific to your financial situation. Unless specifically identified as such, the individuals interviewed or quoted in this piece are neither clients, employees nor affiliates of LearnVest Planning Services, and the views expressed are their own. LearnVest Planning Services and any third parties listed, linked to or otherwise appearing in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies.
