Credit Help: What Happens When You Close an Account?

Credit is one of the most confusing topics out there. Unfortunately, it’s also one topic that is vulnerable to misconceptions, myths and plain old gossip.

One area of credit misunderstanding comes from closing credit accounts. Some people think it hurts their credit score, others think it will increase it. Some people think having a high credit limit that’s not in use will make you less appealing to lenders. Others think having a large number of credit accounts in use is a good idea, others think it’s bad.

So, what really happens to your credit when you close an account? Well, it depends on your credit situation.

Paying Down Debts: If you have several trade lines (credit accounts), and you are working on paying down your debts, it might seem natural to close each account as the balance is brought to zero. In this case, it’s not a great idea.

A large portion of your credit score looks at your utilization of credit. That means the amount of credit you have in use compared to the amount of credit you have at your disposal. For example, if you have five credit cards with a limit of $1000 each, your total available credit is $5000. If each card is maxed out, your utilization is 100%. This is a detriment to your credit, and lowers your score.

While you work at becoming debt free, you make the minimum payments on 4 of the cards, and larger payments on 1 card until the balance is at zero. This now brings your total utilization of credit down to 80%. If you cancel this card right away, it takes that trade line out of the equation, leaving only 4 cards left, at 100% utilization – again.

Credit scores look at individual utilization as well as total credit utilization, but a good rule of credit is the utilization ratio should be about 25% or less. So, until all your trade lines are below that mark, closing a single account can be hurtful.

Inactive Credit: Credit reports are generated and scored based on the activity of your credit. If you have several trade lines not in use, while they may not hurt your credit, you might consider closing one or two.

Many credit cards will go dormant or cancel themselves with lack of use anyway. Utilization ratios are important, because they determine about 30% of your total credit score. However, some people feel they should never close an account because it will permanently damage their score. Not necessarily.

If you have a few different trade lines or credit cards that all remain at less than 25% of the total available credit line, you shouldn’t be affected by closing an account. Assuming you don’t max out the remaining credit, your utilization should remain about the same.

Utilization refers to the balances you carry and is the second highest indicator (next to payment history) of your credit risk. If you want healthy credit, you need to provide a track record of having the discipline to not use every penny of credit at your disposal. This makes you a favourable credit risk, because it shows you’re able to handle your money wisely, without overspending.   

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