If you have multiple credit cards, you might be wondering whether it would be wise to close one of your existing credit card accounts. While closing a credit card is easy, you should carefully weigh the pros and cons before taking a decision.
Here are a few things you must consider before closing a credit card.
Increase in Credit Utilization Ratio
The credit utilisation ratio (CUR) shows the amount of credit that you have used compared to your total credit limit. Credit bureaus give a significant weightage to CUR when calculating your credit score. Hence, maintaining a moderate CUR is beneficial, as it shows that you are not overly dependent on credit. Even unused credit cards contribute to keeping your ratio in check by adding to your overall available credit.
When you close one of your credit cards, your total credit limit decreases, potentially raising your CUR, if your total spending remains unchanged. An extremely high CUR, especially if continued for several months, can negatively affect your credit score.
Suppose you have total usage of ₹1,50,000 collectively on 3 credit cards with limits as follows:
· Credit Card 1- ₹1,00,000
· Credit Card 2- ₹2,50,000
· Credit Card 3- ₹80,000
Now that you have all your credit accounts active, your total credit limit is ₹4,30,000. Based on the used credit amount of ₹1,50,000, your credit utilization will be 30.23 per cent. Now if you decide to close your credit card 2. The total credit limit will be ₹1,80,000. Considering your expenses remain the same at ₹1,50,000, your credit utilization ratio will rise to 72.22 per cent.
Decrease in Credit Age
The length of your credit history also plays a crucial role in your credit score. Your oldest active credit card contributes to a longer credit history as it reflects that you are experienced with credit and skilled at managing your credit accounts over a longer course of time. This is viewed positively by the lenders as well. Closing your first credit card, even if it is unused, can lead to a significant decrease in your credit age and, consequently, may lead to a drop in your credit score.
Losing out on Credit Card Benefits
Every credit card comes with a unique set of benefits, such as complimentary lounge access, co-branded offers, movie discounts, etc. Even if you do not use a particular card frequently, you might still benefit from these additional perks. Hence, it is important to carefully evaluate the benefits of the card you are closing, considering both your current and potential future spending habits.
When does it make sense to close a credit card account?
If you have a credit card that you rarely use, offers minimal benefits, has low credit limit and carries a high annual fee, it might be wise to cancel it. Additionally, if you have multiple credit cards and find it challenging to manage each card responsibly, it could be better to close some of the accounts instead of falling into debt. Struggling to keep up with payments can also harm your credit score. In
such situations, you can consider cancelling a card, preferably the one offering the least benefits. But, do consider it should not have any impact on the age of your credit history.
Before making a decision on closing your card account, conduct a thorough cost-benefit analysis. Identify if you are paying a hefty amount for insignificant benefits or if you can utilize the card’s rewards or cashback structure for savings.
If you do think closing your cards would be helpful, try to minimize the impact. Avoid closing too many accounts at once. If you have multiple unused cards, proceed gradually and consider the age of each account. Instead of discontinuing a card entirely, you can focus on maximizing its benefits and keeping it active, as this can be more advantageous in the long run.
(The writer is Head of Credit Cards Business, Paisabazaar)
Comments
Comments have to be in English, and in full sentences. They cannot be abusive or personal. Please abide by our community guidelines for posting your comments.
We have migrated to a new commenting platform. If you are already a registered user of TheHindu Businessline and logged in, you may continue to engage with our articles. If you do not have an account please register and login to post comments. Users can access their older comments by logging into their accounts on Vuukle.