Is it a good decision to close your unused credit cards?

With the new credit card rules having taken effect from 22nd of February, 2010, it's quite clear that the credit card companies will now lose lots of money as the new laws impose restrictions on charging high rate of interest and various fees. It's also evident that the credit card companies will now look for loopholes in the new act to charge various fees in order to make profit.

In such a situation, many consumers are worried about the annual fees, inactivity fees and other charges that can hit them for not using credit cards for a long time. Thus, it becomes a relevant question if a consumer should close his unused credit cards to avoid being hit by numerous fees.

Does closing unused cards affect your credit negatively?

Closing your credit cards can affect your credit adversely. This is because of the effect the credit utilization ratio has on your credit scores. It is actually a ratio between your credit card balances and the credit card limits. For instance, if you have a credit limit of $5000 and your credit card balance is $2500, you’re using half of the credit card limit and your credit utilization is 50%. If this credit card utilization ratio increases, your credit scores go down.

For example, let's say, you have an open credit card with a credit limit of $4000 and credit balance of $2000. Now, you also have an unused card with a limit of 4000 and balance of $0. Your total credit limit will be $8000 and your total credit card balances will be $2000. Hence, your credit utilization ratio is (2000/8000) % or 25%.

Now, if you close the unused credit card, you are left with the first credit card, with a credit limit of $4000 and balance of $2000, and your credit utilization ratio would be 50%. So, with the closing of the unused card, the credit utilization ratio jumps from 25% to 50% and this triggers a drop in your credit scores.

How do you close cards with minimal effect on credit?

In order to reduce the negative effect on your credit score, you should try and pay down the balance prior to closing a credit card account. If you let the credit card company know that you intend to close the credit card account, they may raise the interest rate on the unpaid balance. Hence, it’s a good idea to first pay off the credit card in full and then, inform the card issuer about your intention of closing the account.

If the credit card issuer charges a high rate of interest on the card and you can find a balance transfer card with lower interest rate and transfer the balance on the low-interest card, thereby paying off the high-interest card.

An even better option is to try and always maintain a low credit card balance. Experts generally advise that you should always maintain a credit balance of less than 10% of the total available credit.

Does closing a credit card eliminate the credit history?

Your credit history does not get deleted when you close your credit card account. If you’ve had a poor payment history on a particular credit card and you’ve closed that account, the negative information will remain your credit report for about 7-10 years before it is taken off the report. On the other hand, if you always made your payments on time, your good credit history will be there on the report, even after you’ve closed the account.