Should you Close Credit Card or Downgrade?
Many people think that closing a credit card is the best option when:
- They no longer want a credit card because of the high costs involved or
- When the card is not used as often, or
- When the benefits program no longer offers what is really needed
But is closing the card most viable option?
To close the credit card without thinking about the consequences is not a smart financial decision. And here’s why:
Effects of closing a credit card
Future Credit Application: Closing the credit card is basically ending the relationship with the financial institution. This is not a positive or negative movement in itself. But depending on other factors, such as the length of the relationship with the card issuer it may have a different effect on a future credit application (in the form of a card).
For e.g. American Express is best known for analyzing customer/company relationship issues when approving a new credit application without specific requirements.
The effects of closing a credit card can be felt for years. Although in many countries credit scoring is not as widespread and publicly disclosed as in others, the companies that make it are virtually the same, with different company names. The globally recognized companies are Equifax, Transunion and Experian.
Loss of Points in Credit Evaluation: One of the most pernicious effects of closing the credit card is the loss of points in credit evaluation. Why does this happen? The answer is simple, one of the components of credit scoring is based on the calculation of the total credit available, or the sum of all the limits of credit card, versus the limit used.
So if you had a $20,000 limit between all of them and closed a $5,000 card when you had $10,000 reported on the balance, the utilization is 75% of the limit, something seen as highly risky for banks.
Credit History: Credit history depends on maintaining open and aging credit lines. Closing a credit card does not help the scoring. Remember, the first thing they measure in credit scoring is the ability to handle credit.
This does not mean having credit card with a balance every month. In fact, if you have the ability to spend only what you can afford, it’s best not to have a card or leave it without any use and only use it every six months to avoid being closed. It is likely that the more credit you use (in the credit rate mix) the higher your score, and as a consequence the possibility that banks will offer you more and better products.
Loss of points or miles: This can be an accessory but real problem of closing the credit card. It is clear that when you close a credit card reward points, pending cashbacks will be all gone. But miles earned remain unchanged and can be kept until the expiration date.
You will lose some of the ancillary benefits of a higher cost credit card. This may seem like a very minor problem, but for many people it can be a major benefit that even exceeds the annual cost of the credit card. Many times keeping the credit card open means getting more benefits than the annual charge.
In short, closing a credit card may not be your best option.
Lower your credit card (change product)
Instead of closing the credit card, a more than satisfactory option in most of the cases is to lower the product or basically change the level to the lowest possible.
For example, if you have a card offering higher level of services, and therefore, a high annual cost then you can ask for change of product or the reduction of the service. And in return, get a card with very low annual cost which is affordable or a card with no annual fee. Best is to get a credit card with $0 annual cost, which is not always possible.
What is possible in many cases is to maintain bank account and card bonus, which would maintain the line of credit, withoutlosing credit score.
Not always the urge to close the credit card is the right decision. Long-term goals must be aligned with the decision. You should always negotiate with the bank for reducing the costs, without change in bonus and other benefits.