Should You Cancel That Credit Card?

What should you do if you have more credit than you need? Should you cancel an unused card, or keep it? How does canceling a credit card affect your credit rating? Take a look with us at the answers to some of these common questions.

Understanding credit utilization

To know whether you should cancel an unused credit card, you first have to understand the concept of "credit utilization" (otherwise known as your "debt-to-credit ratio"). This is the ratio of the credit you use compared to the amount of credit available to you.

A major factor in determining your credit score is this utilization rate – not the size of your credit limits or the amount you have charged to your cards. What matters is the percentage of your available credit that you are actually using. The lower, the better.

Canceling an unused card can negatively affect your credit rating because it raises your credit utilization ratio.

Here’s an example: If you have two credit cards with limits of $2,500 each and you have a balance of $1000 on one and $0 on the other, your overall utilization ratio is 20% ($1,000 / $5000 = 20%)

If you cancel the card with no balance, your utilization ratio would jump to 40%. This higher utilization rate will hurt your credit rating. This is why it's not always the best idea to cancel credit cards you don't use: You want to have the lowest utilization rate possible.

New credit versus old credit

You shouldn’t apply for new cards simply to decrease your utilization ratio: Applying for new credit can downgrade your rating. Each time you submit a credit application, your credit score takes a ding. If you are focused on improving your rating, it is better to ensure that you are using less credit on your existing cards than to add new credit. You could also approach your current credit card companies and ask for them to increase your limits. This would also help you to have a lower utilization rate.

Because your credit rating is also based on the length of your credit history, you want to keep open and in good standing those credit cards that you've had the longest. If you have two credit cards, one from 15 years ago and one you opened 5 years ago, your average credit history is 10 years old. If you were to cancel the 15-year-old credit card, your active credit history dramatically shortens. By keeping older credit cards, even if you don't use them that often, you are preserving your credit history and helping your credit score. 

Lenders may ask you to cancel credit

While a low utilization ratio and long credit history help to boost your credit score, there are times when closing existing credit is beneficial. If you are looking for a new credit card or mortgage and you have unused credit, your lender may ask you to close some of your unused credit before approving new credit or loans. This is because they view that unused credit as a risk, and are looking for ways to limit your chances of getting into too deep of debt. 

More questions on whether you should cancel a credit card? Post them in the comments section below!