Things Consumers Should Consider Before Cancelling A Credit Card
Cancelling a credit card, is not so simple as picking up a pair of scissors and cutting it up. Cancelling the card in the proper way requires more than just a snip, and there is a procedure that should be followed so that the credit card account can be closed permanently. In the first of a series of two articles money-au explains things consumers should think about before cancelling a credit card. In the second piece money-au explains the exact procedure that should be used in cancelling a card.
Why Consumers Should Cancel Cards In The First Place
There are a number of reasons why one would want to cancel their credit cards; it may be the desire to avoid the temptation of excessive spending. Having multiple credit cards encourage individuals to make purchasing decisions they perhaps could live without and would not make were the credit not available in the first place. It also makes sense to close credit card accounts which do not have much use and cost unnecessary money in fees. Most importantly, it is perhaps best to close down credit cards for which interest rates are extremely high, that way consumers by default avoid paying extremely high interest because the card account has been closed.
Another reason to close a credit card account is if consumers are attracted to new cards which offer balance transfers and longer interest free periods or just better deals. In that case it is prudent to maintain the same amount of credit available and close and transfer balances of older cards that offer unattractive terms.
Before cancelling a credit card
Consumers should be aware of a number of things before going through the procedure of cancelling a card account. The most important of which is the possible effect of cancelling an account on the consumers credit history and score. Even after cancellation, the account information doesn’t necessarily come off the credit history.
Positive credit data on an open account can stay on credit reports indefinitely. Closed accounts with zero balances and no associated negative information typically remains on a credit history for 10 years from the date they are reported closed.
Over the last few years, card issuers have focused more on the amount of credit still in use once a card gets cancelled. This is because credit bureaus and lenders are most interested in what is known as a balance-to-limit ratio, or the utilization ratio, which compares the actual amount of credit being used to the amount of total credit available to the borrower. From the lenders point of view obviously a low balance-to-limit ratio is a strong indicator of a borrower who represents a good credit risk,
So the tip here is, when closing one credit card account, ask other lenders to increase the credit limit they provide, so that the ratio can be maintained. If the consumer is unable to negotiate an increase in credit limit after closing a card account then that closure could actually end up hurting the consumers credit score as the utilisation ratio will automatically increase since the total amount of available credit decreases.
To close card accounts without impacting the credit score, consumers need to have only zero balances on their credit report for all of their active credit cards. This is because with only zero balances the credit utilization rate is therefore also zero and cannot be raised potentially hurting the credit score by closing one or more of the active card accounts.
Having excessive access to credit in relation to income is also a liability for consumers. Lenders become risk averse when they see customers whose credit limit in relation to what they earn is inconsistent, the risk being obviously that the borrower ends up spending more than they can afford to pay back.
Consumers should also be aware of the age of the card account. Card accounts with long histories are often valuable to a consumer’s credit profile and have a positive impact on their credit score. Closing such an account could end up having more of a negative impact than a positive impact on the consumers credit score.
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[...] long as consumers are aware of the issues that they should consider before cancelling a credit card, and they have an alternate card they can use, they can then go about the process of actually [...]
In regards to the above post…Australia uses negative credit report system and has no record of “positive” entries….
So how does the utilisation ratio comes of any positive factor comes into it?
You are not suggesting that banks when they decide to lend money or grant a credit facility, do not look at credit limits and what proportion of that limit the person they are extending credit to is using?
If you increase a utilisation ratio by cancelling a card, well for a start credit scoring takes in to account many parameters, but the effect on utilisation ratio needs to be something you think about before doing it.
It has nothing to do whether you default, or whether there has been anything negative on your report. Common sense should tell you that is how lenders appraise risk.
It is not the be all and end all, it is something one needs to think about, hence the title of the piece.