The effect of closing a credit card account on your overall available credit limit
Credit cards have become an integral part of our financial lives, offering convenience and flexibility when it comes to making purchases and managing our finances. However, there may come a time when you need to close a credit card account for various reasons such as high interest rates, annual fees, or simply wanting to simplify your financial situation. While closing a credit card account can provide certain benefits, it’s important to understand the potential impact it can have on your overall available credit limit.
Before we delve into the effects of closing a credit card account, let’s first understand how your available credit limit is determined. Your available credit is the amount of money you can borrow at any given time from all your active revolving accounts (credit cards) combined. This borrowing capacity is calculated based on several factors including income, credit history, and existing debts.
When you close a credit card account voluntarily or due to inactivity or non-usage, the immediate effect is that the available balance on that specific card becomes zero. This means that you no longer have access to the funds associated with that particular card for future purchases or emergencies. Moreover, closing an account also affects your overall available credit limit.
One key factor in determining your overall available credit limit is the total amount of unused revolving debt across all your active accounts. By closing one of these accounts, you’re reducing this total unused debt and subsequently decreasing your overall borrowing capacity. For example, if you had three open credit cards with limits of $5,000 each ($15,000 total), but decided to close one with a $3,000 balance and $2,000 limit; after closure, only two cards would remain with limits totaling $10 000.
Another aspect affected by closing a Credit Card Account is known as “credit utilization ratio.” Credit utilization ratio refers to the percentage of revolving debt compared to your total available credit limit. It’s an important factor that lenders consider when assessing your creditworthiness. By reducing your available credit limit, closing a credit card account can potentially increase your overall utilization ratio.
For example, let’s assume you have two active credit cards with limits of $10 000 each and combined balances of $2 000. This means you have a total available limit of $20 000 and a current utilization ratio of 10%. However, if you decide to close one card while maintaining the same balance on the other card, your overall available limit would decrease to $10 000, resulting in a higher utilization ratio of 20%. Higher utilization ratios may negatively impact your credit score as they suggest increased reliance on credit and potential financial instability.
It is important to note that although closing an account can temporarily affect your overall available credit limit and utilization ratio, it does not erase any negative payment history or late payments associated with that particular account. These factors will continue to be reflected in your credit report for up to seven years.
While there are potential downsides to closing a Credit Card Account regarding available credit limits and utilization ratios, there are also circumstances where it might be beneficial or necessary. For instance:
1. Eliminating annual fees: If a card charges excessive annual fees that outweigh its benefits or rewards program.
2. Reducing temptation: If having multiple cards makes it harder for you to manage debt responsibly.
3. Simplifying finances: Closing unused accounts may help streamline budgeting efforts and reduce unnecessary paperwork.
If you do decide to close a Credit Card Account but want to minimize the impact on your overall available credit limit, consider these strategies:
1. Pay down existing balances: Before closing an account, try paying off as much outstanding debt as possible across all active cards. This will lower both individual balances and overall utilization ratios.
2. Request a higher limit on remaining cards: Contact the issuers of your remaining credit cards to request a higher credit limit. This can help offset the decrease in available credit caused by closing an account.
3. Open a new card with a higher limit: If you’re planning to close one of your cards, consider applying for a new credit card with a higher limit before closing the existing one. This will help maintain or increase your overall available credit.
In conclusion, closing a Credit Card Account can have both immediate and long-term effects on your overall available credit limit and utilization ratio. While it may be necessary under certain circumstances, it’s important to carefully evaluate the potential impact on your financial situation and credit score before making this decision. By understanding these effects and implementing strategies to mitigate their impact, you can make informed choices that align with your financial goals and needs.
Remember, managing your finances responsibly is essential for maintaining good financial health.