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Thinking of Canceling Your Credit Cards? Think Again

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Cancelling one’s credit cards is in vogue these days.  With the financial meltdown, the recession, and the ensuing bank backlash, consumers all over have decided to cancel their credit card accounts and rely solely on cash or debit.

While I can certainly understand the need to give up on debt and force yourself to live within your means, canceling your cards entirely could do more harm than good. There are a few problems with this approach that you need to be aware of before you grab the scissors and start chopping plastic.

Canceling credit cards can hurt your credit

The age of your credit accounts on file has a big impact on your credit score.  Creditors like to see that you’ve had a few responsible long-term credit commitments, rather than a ton of opened and closed short-term loans.  The latter makes you look desperate, which creditors don’t like.  A mortgage is one good example of a long-term commitment, since people tend to hold on to them for a long time.  But credit cards are another easy option, since having the same card for years is effectively the same as a long-term loan in their eyes.  If you have a couple of credit cards that you’ve been using for years, you should think twice before canceling them because it will reduce the life of the loan.  Instead, stick the cards in a drawer where you won’t use them, or cut them up and leave the accounts open.

Another big factor on your credit score is your “debt utilization ratio“, which is the percentage of your available credit limits that you are actually using.  So if you have a $5,000 credit limit on your credit card and you have a $1,000 balance, then your debt utilization ratio is 20%.  The lower that number, the better you look to creditors because a high debt utilization ratio would mean you’re probably overextending or otherwise in trouble.  Now if you have 2 credit cards with $5,000 limits and you have a $2,000 balance on one of them, then your debt utilization is still 20%, but if you cancel one of the cards then it immediately jumps to 40%, which is a lot worse.  This is why it’s better in the end to leave that other account open as un-utilized credit, rather than cancel it.

You need a credit card, whether you like it or not

Even if you don’t feel comfortable leaving accounts open as I describe above, the fact is that you kinda need a credit card these days.  While a debit card will allow you to buy things online and such, there are still things you often can’t do with a debit card, like rent a car.  But more importantly, credit cards act as a layer of defense against fraud that stands between your money and the outside world, while debit cards are a direct line to your cash. So if someone gets ahold of your debit card information, they can potentially clean out your checking account before you realize it.  And while the bank will usually recognize this as fraud and reimburse you, you will have to wait for their investigation and you could potentially miss bill payments or be charged “insufficient funds” fees in the meantime.  With a credit card if you dispute the charge it’s gone, you never have to pay it or worry about it again.

There’s also the emergency aspect.  Sometimes shit happens, and sometimes that requires more money than you happen to have on hand.  Your son might back your new car into the garage door, or your daughter might injure herself playing soccer and require MRIs and such.  In circumstances like this, it’s nice to have a credit card on hand to at least get you through the tough patches.

If you decide to keep them, do it right

For these reasons, I don’t recommend eschewing credit entirely.  Instead, keep the cards that have no annual fees and make sure you pay the balances off in full, so no late payment fees or interest charges come back to bite you later. And for emergencies or other contingencies, keep at least one low APR credit card around for restricted use only.  Keep it out of arm’s reach if you don’t trust yourself, and the benefits will far outweigh the costs of not having a credit card.

Here are a couple of low interest credit cards with no annual fee that are useful to keep open:

  • Steven

    I like that you said “shit happens.”

    I had closed the page, but when I thought you swore I had to come back and double check

    I know this isn’t a family-oriented page (you have to be 18 to apply for credit) but I still respect your choice of words.

    Sometimes, no other word can really describe something as effectively as a “dirty” one.

  • Watashiwasls

    can paying off  car loan also ruin your ‘ratio’? I am about to pay off the last $800 of a $10,000 car loan, and am now concerned that doing so will lower my credit score – or are revolving credit and  installment loans considered differently?

    • http://www.nerdwallet.com/ Tim

      The ratio we speak of here only counts for revolving credit lines.

      • http://pulse.yahoo.com/_EWP2RYTOSPRTCCDLOYYVJS7NWY Phil

        Tim,

        I’ve had the Delta Skymiles AMEX for many years (over 10).  With the recent changes, I am thinking of switching to a different AMEX, probably the Costco.  Will this negatively impact my credit?  (Will I have been with AMEX for 10+ years once I switch – or with Costco AMEX for less than one year?)

        Thanks!

        • http://www.nerdwallet.com/ Tim

          The length of your credit history takes all credit lines into account, not just open lines.

          So no matter what, your old account of 10+ years will continue to dominate your credit score, and opening a new account will have little to no impact. But in the past, I have also had success calling Amex’s customer service directly and switching cards, as you describe, which I believe keeps the account intact.

          I can’t vouch for whether Amex will treat it as such when they report it to the credit bureaus, but in either case there shouldn’t be any negative impact on your score.

          • http://pulse.yahoo.com/_EWP2RYTOSPRTCCDLOYYVJS7NWY Phil

            Thanks!

  • nina

    what’s the difference between a store card eg. amazon, grocery store cards and credit cards. i have an amazon card which a chase visa card.

    • http://www.nerdwallet.com/ Tim

      The Amazon Visa is a standard credit card, so there’s no difference. Many stores, however, have credit cards that can only be used in their store.
      And even many retailers who have Visa/MasterCard versions of their cards use “instant approval” cards, so that you can sign up at the register. This means that these cards are more akin to subprime cards, and have high fees and rates.