Credit Card: How closing an account can impact your credit score

1. Credit Utilization Ratio

Your credit utilization ratio is the percentage of your available credit that you’re currently using. For example, if you have a total credit limit of ₹4,00,000 across multiple cards and your outstanding balance is ₹1,00,000, your credit utilization ratio is 25%. Financial experts recommend keeping this ratio below 30% to maintain a healthy credit score. Closing a credit card reduces your total available credit, which can increase your credit utilization ratio and potentially lower your credit score.

2. Length of Credit History

The age of your credit accounts contributes to your credit score. Closing an older credit card can shorten your average account age, which may negatively impact your credit score, especially if you don’t have many other long-standing accounts.

3. Credit Mix

A diverse mix of credit types—such as credit cards, installment loans, and mortgages—can positively influence your credit score. If the card you’re considering closing is your only account of a particular type, doing so could reduce the diversity of your credit mix and potentially lower your score.

4. Payment History

While closing a credit card doesn’t erase its payment history from your credit report, it’s important to ensure that any outstanding balances are paid off before closing the account. Outstanding debts can negatively impact your credit score.

Considerations Before Closing a Credit Card

• Annual Fees: If a card has high annual fees and you’re not utilizing its benefits, it might make sense to close it.
• Spending Habits: If having multiple credit cards leads to overspending, closing one could help you manage your finances better.
• Financial Simplification: Managing numerous credit accounts can be overwhelming. Closing an unused card might simplify your financial management.

Steps to Take Before Closing a Credit Card

1. Redeem Rewards: Use any accumulated rewards or points before closing the account to avoid losing them.
2. Pay Off Balances: Ensure all outstanding balances are paid in full to prevent negative impacts on your credit score.
3. Monitor Credit Utilization: Be aware of how closing the account will affect your credit utilization ratio.
4. Update Automatic Payments: If you have recurring payments linked to the card, update them to another account to avoid missed payments.

Consult a Financial Expert

Given the complexities involved, it’s advisable to consult a financial expert before closing a credit card account. They can provide personalized advice based on your financial situation and help you navigate the potential impacts on your credit profile.

In summary, while closing a credit card can simplify your finances, it’s crucial to consider how it will affect your credit utilization ratio, length of credit history, and credit mix. Taking these factors into account will help you make an informed decision that aligns with your financial goals.