Over time, we all open credit accounts to help us with our financial situations, liquidity, or to just get some nice signup bonuses.
Typically, we would use these accounts for a year or two, and they would either become an integral part of how we manage our finances, or we would stop using them completely. If an account fell into the latter category, you might be tempted to get rid of that extra plastic taking up real estate in your wallet and close the account.
However, is it a good idea to close unused credit card accounts?
While common sense might suggest that you should close the account, the reality is that this could end up hurting your credit score. We’ve broken down everything you need to know about closing credit accounts in our guide here, so read on to find out more!
Credit Utilization Ratio
The first thing you need to understand about closing an unused credit account is the effect it can have on your credit utilization ratio.
Your credit utilization ratio refers the the total amount of money you have spent across your revolving credit accounts compared to the total amount of credit you have been approved for. Your revolving credit accounts refer specifically to credit cards, and your total approved credit amount would be the limit on each of those cards added together.
Your credit utilization ratio can be calculated on a card per card basis, or as an overall total of all your spent credit compared to all of your approved credit. Different credit bureaus will weigh card vs total credit utilization differently, so depending on your situation, your FICO score and your VantageScore could be substantially different.
Now, this is where things get interesting.
All of your credit cards contribute to your overall approved credit amount. Even if you have an unused credit card sitting in a drawer gathering dust, it is still providing an extra couple thousand dollars towards your overall credit. Simple maths tells us that the higher your total approved credit, the less of an impact your spending will have on your credit utilization ratio. For example, if you had an overall approved credit limit of $5,000 and then spent $1,000, your credit utilization ratio would be 20%. However, if you only had a total approved credit limit of $3,000 and you spent $1,000, your credit utilization ratio would be 33%. Thus, you can see that the impact your spending has on your credit utilization ratio is directly proportional to your total approved credit limit.
Now, if you were to close that unused credit card account, you would be removing it’s approved credit limit from your total approved credit. This would, in turn, increase your credit utilization ratio and make all of your spendings have a greater impact on your ratio. Unless your card comes with a hefty yearly fee or there is some other pressing reason why you need to close the account, it is best to leave unused credit card accounts open to help manage your credit utilization ratio.
If the card you wish to close does have a yearly fee that you would rather not pay, consider calling your credit provider and asking whether they would waive the fee in order to keep you as a customer. Do not be afraid to leverage your past relationship with the lender, especially if you have been a long time customer that hasn’t missed any payments in many years. You’ll be surprised to see that many lenders are willing to play ball and will offer a discount or even fully wipe the yearly fee for you!
Older Credit Accounts Hold More Weight
Another thing to consider before closing an unused credit account is how old the account is.
Credit bureaus tend to weigh older credit accounts more heavily than newer accounts. What this means is that the credit card you opened when you turned 18 and still have to this day is actually a powerful credit account that shows credit bureaus you have been a credit user for many years. As the length of credit history plays an important role in both FICO and VantageScore credit scoring models, it is generally advised you keep your oldest credit accounts open for as long as possible.
This piece of advice will apply mainly to Canadians who have lived here their entire lives and opened credit accounts when they were teenagers. Your first credit card, for example, was likely a no-fee credit card with a low credit limit as you were still figuring out how to manage your finances. If you still have this card with you to this day, it is best to keep it open indefinitely, as it is your oldest established credit relationship and will carry the most weight with a credit bureau.
If you are recent arrival to Canada, you won’t have this long-established credit history, as credit histories do not follow you from country to country. In this case, you should try to open a credit card account as soon as possible and then keep that account open indefinitely. This will help you build your credit history and show credit bureaus that you are a trustworthy credit user.
One way you can get a credit file started without a credit history is through opening a secured credit card. This is a kind of credit account where you give the bank a certain amount of money, say $500, and then they give you a credit card with that amount as the credit limit. This means the account is “secured” as you have already paid the bank for it, but it will appear on your credit file as a regular revolving credit account, just like any other credit card.
Again, if your unused credit card account is one you have had for a long time, it is best to leave it open for as long as possible. Credit bureaus will weigh older credit accounts more heavily than newer accounts, so closing an old account could potentially damage your credit score.
Use it at least once per year
Something you might not know is that many credit providers require you to use a credit account at least once per year or they will close the account for you.
As we have discussed above, it is really not in your best interests to close an unused credit account unless it is costing you money in some way. However, if you truly do not use it at all throughout a year, your credit provider might not give you a choice and will close the account for you. If you aren’t paying close attention, this might happen without you even noticing and it could blow your credit utilization ratio out of the water.
A handy way to deal with this is to set up an automatic bill payment for a yearly bill, such as a club membership or other yearly service charge. That way, at least once a year, your “unused” credit card will get used and you can rest assured that it won’t get closed by the credit provider without you realizing it.
Another way you can ensure you always use the card at least once per year is to set a reminder in your phone or computer to use that card for some small purchase on a particular date every year. This could be a little as a few dollars at the grocery store – any charge counts as long as it is made once per year with that specific credit card.
Set these systems up and you’ll be guaranteed to keep your card for as long as you want!
Replace With More Credit
If you absolutely need to close that unused credit account, you should consider topping up your total approved credit.
This can be done in one of two ways. Firstly, you could simply open a new credit card account with the same balance as the card you just closed. You should make this credit card a no-fee card so you have no reason to close it should you stop using it as well. This will allow you to establish another long term credit account, while also giving you more breathing room in your total approved credit amount.
The second way you can increase your total approved credit is through requesting credit limit increases on any of your remaining credit cards. This one can potentially be even easier and less risky than applying for new credit cards, assuming you have been paying your bills on time and have a good relationship with your credit provider. Many banks and credit unions will even allow you to request a credit limit increase through their online portal, with approval sometimes given on the spot. You should aim to increase your credit limit by whatever amount your recently closed account’s limit was. This will help you to maintain your credit utilization ratio and moderate the impact of your spending.
This can actually be a good opportunity to shop around for better credit card deals and negotiate better rates with your credit providers. If you have a good credit history and have been with the lender for some time, they are usually fairly open to aggressive negotiation to retain you as a customer. Do some research and find out what other lenders are offering, then take that to your current provider and see if they will match or beat it. Keep an eye out for rewards credit cards that offer a welcome bonus and first year free for any membership fee – these can add up quickly and get you on your next vacation for next to nothing!
Contrary to popular belief, it is actually not beneficial to your credit score to close an unused credit account. As your score is a direct reflection of your trustworthiness with credit, lowering your total credit amount is actually a surefire way to get your credit score reduced. Try to keep no-fee credit cards open for as long as possible, as the older the account, the more heavily it will impact your credit score. Finally, if you do have to close an account, consider replacing it with either a new credit card or request a credit limit increase on your other cards. Follow these steps and your credit score will be flying high in no time!