Does Closing A Credit Card Improve Your Credit Score?

Managing credit cards effectively is crucial for maintaining financial health, but many consumers wonder whether closing a credit card can improve their credit score. While it may seem like a logical step to reduce financial risk, closing a credit card can have unintended consequences on your credit profile.

Understanding Credit Scores

Credit scores in Australia are calculated based on several factors, including:

• Payment History: Timely repayments on loans and credit cards.
• Credit Utilisation Ratio: The percentage of your available credit that you use.
• Length of Credit History: How long you’ve had active credit accounts.
• Credit Mix: The diversity of your credit products, such as mortgages, personal loans, and credit cards.
• Recent Credit Inquiries: Applications for new credit products.

These elements collectively determine your overall creditworthiness. Closing a credit card can impact multiple aspects of your score, which may result in more harm than good.

How Closing a Credit Card Impacts Your Credit Score

Closing a credit card does not automatically improve your score. Instead, it can affect three key areas of your credit profile:

Credit Utilisation Ratio

The credit utilisation ratio is one of the most significant factors influencing your score. This ratio represents the amount of debt you owe compared to your total available credit. For example:

• If you have two cards with a combined limit of $10,000 and a balance of $2,000, your utilisation ratio is 20%.
• Closing one card with a $5,000 limit reduces your total available credit to $5,000. If the balance remains $2,000, your utilisation ratio jumps to 40%, negatively impacting your score.

Credit scoring models favour lower utilisation ratios because they indicate responsible financial behaviour. Closing a card reduces your available credit and could make you appear over-leveraged.

Length of Credit History

The length of your credit history accounts for approximately 15% of your score. It includes the age of your oldest account, the age of your newest account, and the average age of all accounts. Closing an older card can shorten this average, potentially lowering your score.

For instance:

• If you close a card that has been active for ten years while keeping newer accounts open, it may signal less stability and experience to lenders.

Credit Mix

A diverse mix of credit products demonstrates that you can manage various types of debt responsibly. Closing a card reduces the diversity in your credit portfolio, which could negatively affect this aspect of your score.

Reasons to Close a Credit Card

While closing a card may not boost your score directly, there are valid reasons for doing so:

1. High Fees or Interest Rates: If the card has excessive annual fees or high interest rates that outweigh its benefits.
2. Overspending Habits: To prevent impulse purchases and manage spending better.
3. Fraud Concerns: If you suspect fraudulent activity or feel the card is vulnerable to misuse.
4. Simplifying Finances: Reducing the number of active accounts for easier management.

Steps to Close a Credit Card

If you decide to close your card, follow these steps to minimise any adverse effects:

1. Pay Off Outstanding Balances: Ensure the balance is fully paid off before initiating closure. Any pending transactions or interest fees must be settled.
2. Redeem Rewards Points: Claim any accumulated rewards points before closing the account. Many banks have deadlines for redeeming points after account closure (e.g., NAB allows 60 days).
3. Check Your Transactions: Review recent transactions to ensure no pending charges remain on the account.
4. Get Written Confirmation: Request official documentation from your bank confirming the account closure.
5. Destroy the Card: Cut up the physical card along its numbers and microchip to prevent future use.

Alternatives to Closing Your Credit Card

Instead of closing a card outright, consider these alternatives:

1. Lowering Your Credit Limit: Reduce the limit to curb spending while keeping the account active.
2. Switching Cards: Upgrade to a low-interest or no-fee option if fees or rates are an issue.
3. Keeping It Open with Minimal Use: Use the card sparingly for small purchases and pay off balances immediately to maintain activity without overspending.
4. Balance Transfers: Transfer outstanding balances to a low-interest card if repayment is challenging.

Tips for Managing Credit Cards Effectively

To maintain or improve your credit score while keeping accounts open:

• Pay off balances regularly to reduce utilisation ratios.
• Use cards responsibly by limiting purchases and avoiding maxing out limits.
• Monitor credit reports periodically for errors or fraudulent activity.
• Keep older accounts open when possible to preserve the length of credit history.

Does Closing a Credit Card Ever Improve Your Score?

In rare cases, closing a card may positively impact your financial health if it helps you avoid overspending or simplifies debt management. However, this benefit typically comes from behavioural changes rather than direct improvements to your score.

For example:

• If you struggle with debt repayments and closing one account prevents further accumulation, it could help stabilise finances over time.

Still, this approach should be weighed carefully against its potential impact on utilisation ratios and average account age.

Conclusion

Closing a credit card does not inherently improve your credit score; instead, it often leads to unintended consequences such as higher utilisation ratios and reduced average account age. Before making this decision, evaluate whether alternatives like lowering limits or switching cards might better suit your needs.

By understanding how various factors influence credit scores and managing accounts wisely, you can achieve financial stability without compromising your profile’s strength.