Find out if cancelling a credit card can impact your credit score.

Closing an existing credit card may be wise in certain situations, especially when its burden outweighs its benefits.

But before you close that account and shred the card, pause and think of the consequences of such action on your credit score.

Cancellation of credit cards can sometimes negatively impact your credit score. The stake gets higher when you only have a few credit cards. Let's take a look at how cancelling a credit card can affect your credit score and if it is the right step for you:

When cancelling a credit card makes sense

Sometimes it may be wise to cancel some credit cards in situations like the following:

The annual fee is high compared to its benefits

Ideally, credit cards with high annual fees have more benefits and perks like frequent flyer miles, reward points, discounts, and even an attractive welcome bonus. If the credit card issuer is not offering benefits that compensate for the high annual fee or the benefits just aren’t useful to you, it may be wise to cancel the card.

The interest rate is high

High-interest rates on a credit card can quickly accumulate and make it challenging to keep up. If you do not pay off your credit card balance on time every month, you are charged interest on your outstanding balance. With a high-interest card, it can become hard for you to offset your balance when credit card bills are due.

You have too many credit cards

Holding multiple credit cards with large credit limits can turn you into an impulsive buyer. After all, cash isn’t directly being debited from your account, and you know your cards can accommodate your spending.

Before you realise it, you may end up accumulating large debts and losing control over your finances. To control your spending, it may be best to cancel some of your credit cards.

You need to upgrade your card

With time, you may want to change your credit cards to match your current status or situation.

For instance, you may need an upgrade from a student card to a regular card when you are no longer a student. Some credit card companies automatically upgrade you to a new card. Others may require you to apply for an upgrade separately.

If your credit card provider does not offer a good upgrade deal, you may decide to cancel the credit card and get a new credit card somewhere else.

When to keep your credit card account open

There are also instances when cancelling your credit card may not be the best option:

It is the oldest account in your credit history

Even though they are collecting dust, it may be wise to hold on to your old cards to maintain your credit history. Closing old credit cards can decrease the average age of your accounts. In fact, the length of your credit history is generally considered by credit reporting bodies when calculating your credit score, though the specific weighting varies between providers.

Closing a credit card can also decrease your overall credit limit and increase your credit utilisation ratio if you maintain the same balance or spending pattern. Your credit activity - or credit activeness - is a contributing factor to your credit score and report, so closing a credit card reduces your credit activity. However, individual circumstances will vary and keeping credit cards open unnecessarily to maintain credit scores is not advised.

You have a limited number of credit accounts

Cancelling a sole credit card can hurt your credit score, too. Credit activeness can be a factor in credit scoring, though the weighting varies between different credit reporting bodies and lenders. Having only a few accounts on your credit history may lead to a thin credit report and a lower credit score.

It is the credit card with the best offering

You may want to resist the urge to close a credit card that offers excellent perks and relatively low charges. If you are considering cancelling some of your cards, you may want to evaluate the terms of each card to know which one is worth eliminating and which one to keep.

How cancelling a card can hurt your credit score

Here’s the thing: Credit cards affect credit score in a lot of ways. The negative effect of cancelling a card on your credit score depends on the features of the credit card you are closing and your overall credit history as well.

Closing a card with the highest credit limit can increase your credit utilisation ratio and, in turn, hurt your credit score. High credit utilisation tells lenders that you are stretched thin with your finances, which can also make it difficult for you to get a new line of credit.

Moreover, if you don’t have a very exhaustive credit history, cancelling a credit card, which may only be one of the few open credit accounts in your report, can impact your credit score as well. All in all, cancelling a credit card can affect your credit rating in Australia, but it all depends on how much impact that card has on your credit report.

How cancelling a credit card can improve your credit score

Lower your debt risk

Some lenders consider your credit limit a potential debt even if you have zero balance. A high credit limit constitutes a risk to new lenders because you can decide to utilise the limit at any time. Cancelling cards can reduce your credit limit and improve your credit score.

Better control over your debt

To cancel your credit card, you have to pay all outstanding balances. If you have a record of payment default on the card, cancelling it shows you are settling your debts. Note that late payments affect your credit score as well. Therefore, you should try to settle any outstanding credit card bills as soon as possible.

More room to settle other balances

Cancelling one credit card shifts your priority to the others. You can channel your income towards settling other accounts by their due dates, all the while decreasing your overall debt. This can improve your credit history and your score.

Control impulsive spending

More credit cards mean a bigger credit limit. If you struggle to control your finances due to impulsive buying with credit cards, closing some of them may help prevent impulsive tendencies.

What are the alternatives to cancelling a credit card?

Negotiate a lower interest rate

If you are closing a credit card because of a higher interest rate, you can instead contact your credit card provider to negotiate a lower interest rate. Most providers may willingly offer a low interest rate when you clearly mention that you are planning to close your card.

You can also downgrade your card to a lower-interest or no-annual-fee card.

Maintain your credit card to improve your chances of getting a better card

If you are not qualified for a card with better terms due to a poor credit score, you can focus on maintaining your current card by keeping your account active and paying off your balance when due. Doing this can improve your credit score and increase your chance of getting a better credit card.

Control your spending

If you struggle to live within your means due to a credit card, cancelling it may not be the remedy. Instead, you can keep your card away and only use it during emergencies.

Does closing a credit card account impact your credit score?

Closing a credit card account can affect your credit score and credit history as well. But it may not be the case in every instance. If the card you are cancelling has a high credit limit, it can raise your utilisation ratio and reduce your credit score.

But if you are just closing the credit card to clear off your debt and get better control of your finances, it may lead to a higher credit score in the long run.

How to safely cancel your credit card

Here are some tips to safely cancel your credit card while minimising any risks:

• Pay off all your existing balances or transfer your debts to a balance transfer card

• Redeem all your rewards

• Contact your card issuer to close your account

• Send a cancellation letter to supplement the call

• Consistently check your credit report to ensure the credit card cancellation reflects in your credit report.

So, in answer to the question, “Does cancelling a credit card hurt your credit?”...

The decision to close your credit card is subjective. This article helps to cover some of the main considerations, but your individual circumstances will be unique to you. Consider the pros and cons of a credit card before taking the bold step. You may also want to check your credit report to understand what your credit profile looks like today.

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This article provides general information only and does not constitute financial advice. Individual circumstances vary, and you may wish to seek independent advice before making financial decisions. Information is accurate at the time of writing and may change.