2684: Should You Cancel Your Credit Card After Paying It Off by Kumiko of The Budget Mom on Frugality

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[00:00:54] This is Optimal Finance Daily, Episode 2684.

[00:00:58] Should you cancel your credit card after paying it off?

[00:01:01] By Kamiko of thebudgetmom.com.

[00:01:04] And I'm your host and personal finance enthusiast, Diana Merriam.

[00:01:08] Now let's get right to today's post as we optimize your life.

[00:01:16] Should you cancel your credit card after paying it off?

[00:01:19] By Kamiko of thebudgetmom.com.

[00:01:22] Congratulations, you finally paid off your credit card.

[00:01:25] You worked long and hard and it has finally happened.

[00:01:29] Your credit card balance is down to zero.

[00:01:32] You might be wondering what to do with your credit card now that it's paid off.

[00:01:36] Do you leave the card open or should you close it?

[00:01:39] This week on Instagram, I shared with you that I finally paid off my Chase credit card.

[00:01:44] In my picture, I showed you the cut-up credit card in little pieces lying next to a pair of scissors.

[00:01:49] Many of you ask, why did I decide to cut it up and did I close my credit card account after paying it off?

[00:01:55] Before I talk about what I decided to do, let's talk about the pros and cons of closing a credit card after it's paid off.

[00:02:02] The pros of closing your credit card.

[00:02:05] I have decided to close credit cards in the past, but I did so without thoroughly thinking things through.

[00:02:11] If you were to ask me right now if you should close your credit card, my answer would be probably not.

[00:02:18] In my opinion, there are only two real benefits to closing your credit card after you pay it off.

[00:02:24] Avoiding temptation.

[00:02:27] The number one reason most people choose to close their credit cards is to avoid temptation.

[00:02:32] Not being able to use your credit card forces you to avoid future debt.

[00:02:37] If you have a spending problem or are managing a heavy debt load,

[00:02:41] it might make sense to close some cards as you pay them off to minimize your temptation to spend.

[00:02:47] Minimizing fees.

[00:02:50] If your credit card is charging you fees, you should think about closing it.

[00:02:54] For example, many cards charge you an annual fee just for having the card.

[00:02:59] If you're not using it anymore, canceling the card will save you those costs each year.

[00:03:04] Some credit cards will even charge you an inactivity fee,

[00:03:07] which means you're paying the credit cards for not using them.

[00:03:10] To me, this is a waste of money.

[00:03:13] The cons of closing your credit card.

[00:03:16] It's a common misconception that closing your credit card will increase your credit score.

[00:03:20] The truth is, it's more likely that closing a credit card, even one with a zero balance,

[00:03:26] will hurt your credit score rather than help it.

[00:03:29] Credit utilization.

[00:03:31] Your credit utilization is the amount of your credit card balance compared to the credit limit.

[00:03:37] Your utilization essentially measures the percentage of your available credit that you're using,

[00:03:43] and it makes up about 30% of your credit score.

[00:03:46] That's a pretty huge chunk.

[00:03:48] When it comes to your credit score, you want to keep your utilization low.

[00:03:52] If it's high, this indicates that you're probably spending a lot of your monthly income on debt payments,

[00:03:58] which can put you at a higher risk of defaulting on your payments.

[00:04:02] If you decide to close an unused card, you're reducing your available credit without decreasing your credit usage.

[00:04:09] Let's look at an example.

[00:04:11] Let's say you have three different credit cards.

[00:04:13] You owe $1,500 on the first two, which have $3,000 credit limits,

[00:04:18] and your third card has a $4,000 limit but no balance.

[00:04:23] Right now, you're using 30% of your available credit, which is $3,000 in balances out of your $10,000 in available credit.

[00:04:32] If you decide to close the $4,000 credit limit credit card that has a zero balance

[00:04:37] and the one you're not using, your credit utilization jumps to 50%,

[00:04:42] which has a negative impact on your credit score, so your $3,000 in balances out of $6,000 in available credit.

[00:04:50] Remember, you want your utilization to be low.

[00:04:54] Credit history.

[00:04:56] No matter what you've heard, closing your credit card won't erase the card's history from your credit report,

[00:05:02] nor will it keep the history from being included in your credit score calculation.

[00:05:06] Negative information remains on your credit report for at least seven years from the date it occurred.

[00:05:12] Your positive information, however, can fall off sooner than that if the card stops reporting it.

[00:05:18] If you keep the card open, that positive information, which helps your payment history and your length of credit,

[00:05:24] will stay on your credit report and helps your credit score indefinitely.

[00:05:28] One thing you want to remember is that old credit is the best credit.

[00:05:33] The age of a credit card account is also essential when it comes to your credit score.

[00:05:38] In theory, the longer your credit history, the more accurate lenders can be

[00:05:42] in determining the level of risk they take on when lending to you.

[00:05:46] Everyone has a unique credit history, so closing an older account

[00:05:50] can negatively impact you more than it does for someone else.

[00:05:54] As an example, if you're young and have a short credit history,

[00:05:57] closing a credit card account could hurt your overall score more than someone in their 60s who has a much longer credit history.

[00:06:04] So what did I decide to do with my credit card?

[00:06:07] I cut it up, but I decided to keep the account open.

[00:06:10] My situation is a little unique because I want to buy a house in the next year or so.

[00:06:15] Closing a credit card account can hurt you if you're attempting to get a mortgage.

[00:06:19] Before you do anything, it's important to ask yourself if you're going to be making a major financial move in the short term.

[00:06:25] The risk of the short term drop in your credit score is higher than the risk of just cutting up the card and forgetting about it.

[00:06:32] For me, I decided to cut up my card.

[00:06:34] I will do so with every card I pay off, and I'll hold on to the account until I'm past my home buying hump.

[00:06:41] Everyone's situation is unique, and it's essential for you to weigh all the pros and cons before closing your credit card account.

[00:06:49] You just listened to the post titled Should You Cancel Your Credit Card After Paying It Off?

[00:06:56] by Kamiko of thebudgetmom.com

[00:06:59] and I'll be right back with my commentary.

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[00:09:11] I completely agree with Kamiko here.

[00:09:13] If a credit card doesn't have an annual fee, I see little reason to close it.

[00:09:18] Unless of course you think it will tempt you to overspend.

[00:09:21] And even if the card does have a fee, you can call and have your card downgraded to an option with no annual fees and then leave it open.

[00:09:30] Another reason why I leave all my credit cards open is for easy access to short term credit.

[00:09:36] If I had a large expense that I needed to pay for right now, I might need a few days to get the funds moved over from my savings account to my checking account.

[00:09:46] So by charging it on the card, it gives me a little bit of time to move some money around.

[00:09:51] And I won't pay any interest because I'll pay it off in full when the bill is due and not carry a balance.

[00:09:57] Now while this might sound counterintuitive, if I had enough time when coming up on a large expense,

[00:10:04] I'd apply for a new card with a good signing bonus of credit card rewards points.

[00:10:10] I've dabbled a bit in credit card hacking or churning where I open a card,

[00:10:15] spend just enough to earn the signing bonus of points and then move on to the next card.

[00:10:21] I've found that the only real way to get a meaningful amount of points to make it worth the trouble is from the signing bonuses.

[00:10:28] But you usually need to spend $3,000 to $5,000 in the first three months of having the card open,

[00:10:33] which is typically outside my normal spending range.

[00:10:37] Now keep in mind that I only started having fun with credit cards in this way after I got completely out of debt

[00:10:43] and overcame any temptation to overspend.

[00:10:46] This only works out favorably for me because I am 100% committed to never carrying a credit card balance again.

[00:10:53] And that should do it for today. Have a happy rest of your day and I'll see you on the Tuesday show tomorrow,

[00:10:59] where your optimal life awaits.