People whose credit scores are lower than they want commonly and understandably attempt to improve their scores. That occasionally leads to the implementation of unproven strategies that seem to make intuitive sense, but could instead actually backfire.
The most common of these wrongheaded “common-sense” approaches may be closing unused credit card accounts: Surely closing unused credit cards will help your credit scores? Surely having too many open credit cards is a drag on your scores that can be instantly eliminated by closing them? But no, that’s wrong on both counts.
The reason closing credit card accounts won’t help credit scores, and in fact can actually lower them, is because of an important metric in credit scoring systems called the debt-to-limit ratio or “revolving utilization.” This metric compares your existing credit card balances to the combined credit card limits on all of your open cards. So, if you have $2,000 in balances on your cards compared with $10,000 in the combined limits on your cards, your debt-to-limit ratio is 20 percent because you’re using 20% of your aggregate credit limit. Twenty percent is a pretty low ratio and would be helpful to your credit scores.
Closing one or two unused credit cards in an effort to improve credit scores would remove some percentage of the “limit” portion of the debt-to-limit ratio measurement. For simplicity, let’s say the closed card has a $5,000 credit limit. That would leave a $2,000 balance owed and only $5,000 for your total spending limit, which instantly doubles your debt-to-limit ratio to 40 percent from 20 percent. That’s admittedly an extreme example, but even closing cards that represent a smaller percentage of your total debt limit would drive that ratio higher, and that’s why closing credit cards won’t bring higher credit scores.
Now apply this knowledge to the holiday shopping season—and the arrival of bills that follow in January. Seasonal gift buying typically brings an increase in outstanding card balances – pushing up the “debt” side of the debt-to-limit ratio. Closing one or more unused cards in the wake of that– perhaps in a New Years’ resolution to boost credit scores—would lower the “limit” side of debt-to-limit ratio at the same time, a one-two punch that could decrease scores considerably.
Generally speaking, closing a credit card isn’t really a good idea except under one condition: If the temptation to use a particular card is too great to overcome, it’s better to close the account than to get overwhelmed by impulse spending. Taking that step may lead to lower credit scores, but that’s a better than getting buried in out-of-control debt.