I received the following email from a client asking about when to cancel a credit card. They have a couple of cards now and are unsure whether it is worth it to pay the annual fees. Keep reading to see how we addressed their situation.
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Question from reader
Hi! We now have several credit cards and have been earning points… Awesome. My question is “should we ever cancel them?” I’ve heard that canceling your cards can lower your credit score, but with the cards that have yearly membership fees it can add up. And we just were declined for one because we have too much credit. What is your advice on this? Thanks!
How canceling a credit affects your score
There are several components of a credit score, and canceling a card can potentially affect two of them that make up 45% of your credit score.
Amounts owed – aka utilization ratio
The 2nd largest component of your credit score is the amount you owe compared to the lines of credit that you have been approved for. When you close a card, the amount of credit that you have been approved for will decrease.
For example, say you have 2 credit cards, each with a $10,000 limit, for a total of $20,000 in approved credit. You have $5,000 outstanding on one of the cards (the card you intend to keep) and $0 on the other card (which you are thinking of closing). Currently, you have a utilization ratio of 25% ($5,000 balance owed vs. $20,000 approved credit). A utilization ratio of 25% is in the ballpark of what many people say is in the “good range.” Personally, I believe you should pay off your cards in full every month.
If you close the card with a $0 balance, the $10,000 credit limit goes away, leaving you with a $5,000 balance and $10,000 in approved credit. Your utilization ratio now jumped from 25% to 50%!!! This will certainly affect your credit score in a negative way.
Length of credit history
Banks and other creditors want to see that you’ve been able to handle your credit responsibly for an extended period of time. Generally, the longer your credit history, the better.
One factor that goes into this is the average age of your accounts. If you are planning on canceling a card that you’ve owned for a long time, this could end up lowering your average age of accounts. If the card is only a couple of years old, you could actually increase your average age and your credit score.
My recommendations
After speaking with this reader by phone, and finding out more about their situation, here is what I suggested.
For the declined application
The reader was denied a credit card due to having too much credit already with the bank. I said that she should call the bank’s reconsideration line to 1) see if they would manually approve her for the card, 2) see if they would be willing to transfer some unused credit lines from another card to approve this one, or 3) offer to close a card that she doesn’t like very much in exchange for obtaining approval of the card she really wants.
For cards with annual fees
We all should be mindful with how we spend our money, whether we’re at the mall and a new outfit is calling out to us “bring me home” or with annual fees on the credit cards we hold. Spending money is OK if it fits within your budget and you are receiving adequate value for your hard-earned dollar.
We talked about a couple of the cards that she has, and we talked about the value of paying an annual fee on one of her cards because she prefers to fly that airline and likes the “no fees for checked bags” that the card provides.
For another card, I recommended looking at downgrading to a no-fee version of the card. Most banks have multiple tiers of their cards to fit the budget of most consumers. There is often a no-fee version with low benefits, a mid-tier card with good benefits targeted to those who see value in the benefits worth the annual fee, and a premier version that is targeted to the affluent customers that offers top-level benefits.
Conclusion
Your credit history and the credit cards you own should be viewed as assets that will help you achieve your goals. Much like chess, you need to know how each pieces works within your strategy and use them accordingly to “win” more benefits for your family.
If you would like some personal guidance in what to do with you cards or help in picking out the cards that will help you reach your goals, please drop me a line.
