Policies, Codes & Other Documents
The reasons behind closing a credit card can be many - from switching to a card with better functionalities to using debit cards alone because the annual fee is too high.
Irrespective of the reason, the cardholder must be cautious and think about the decision. Cancelling a credit card can have a detrimental impact on one's credit score. Hence, this is a small move which can have negative repercussions for years to come.
On the brighter side, there are ways to close the credit card safely. This article discusses the probable impact of the closure of a credit card on one's credit score and how to mitigate it.
Deciding to deactivate a credit card can result in a credit score setback if not considered carefully. This is why experts suggest letting credit cards remain open. However, their high annual fee or other reasons may propel owners to request a cancellation.
While there are several valid reasons for cancelling a credit card, one must consider the repercussions. For starters, it is vital to understand that cards with the highest credit limits can cause the most damage and affect one's credit utilization ratio. The credit utilization ratio is one of the key criteria for determining one's credit score and refers to the percentage of a borrower’s total available credit that they are currently using.
For example, Mr X has three credit cards with a total spending limit of Rs. 5 lakh per month. He only utilizes Rs. 2 lakh on average every month from his credit limit. Here, the average credit utilization ratio of Mr X is 40% (Rs. 2 lakh/Rs 5 lakh*100).
While lowering the credit utilization ratio can help improve one's credit score, closing a credit card will not have a similar effect. For instance, in continuation to the above example, say Mr X has a limit of Rs. 2 lakh for a credit card, and he wants to discontinue this card. Now, his credit limit is down to Rs. 3 lakh. Assuming that his credit spending remains at the same level, his credit utilization ratio would change significantly.
New credit utilization rate = INR 2 lakh/INR 3 lakh*100 = 66.67%.
According to experts, the credit utilization ratio should be maintained at around 30%. A higher credit utilization ratio signifies that the person depends more on credit, which can be a worrying sign for lenders.
Moreover, the credit utilization ratio can impact up to 30% of a credit score. Hence, having a high credit utilization ratio can push the holder to the brink of harming their credit score.
In the above example, after Mr X closed one of his cards, his ratio of utilization jumped to two-thirds, exposing him to the risk of denting his credit score.
Another aspect that impacts the credit score is the age of the credit cards. The older the card, the better the credit score. While it may not have as significant an impact as the credit utilization rate, it holds some significance.
Here are the potential situations when a user should opt to cancel their credit card -
Note that the closure of credit cards can lead to the cardholder getting shifted to a “thin” credit report category if they do not have a lot of other open accounts. This would make achieving a high credit score difficult and finding future credit arduous.
It is a good idea to check one's credit report before cancelling a credit card. It will help gauge if the cancellation will affect one's credit history too negatively.
Most people do not opt for closing a credit card unless there are legitimate reasons to back the decision. While the cause varies, the user must remember that cancelling a card will not result in its removal from their credit report.
However, if cancelling a credit card is the only way out, here are the steps to do it safely -
The decision to cancel credit card transactions is straightforward, but closing a credit card itself is not easy and requires careful pondering. So, unless the card is burdensome, the holder should find an alternate way to tackle the problem, such as requesting a fee waiver or lowering the limit.
While the decision to close a credit card account may not impact the credit score directly, several ancillary factors can do so if done haphazardly. For instance, deactivating a credit card can impact the credit utilization ratio, which will ultimately impact the credit score.
In case cancelling is the only resort, the holder must ensure they have understood all the requirements to close their account safely. They should also get in touch with the issuer to ensure a smooth cancellation. Debt is one of the main reasons for cancelling credit cards. For those looking for a consolidation loan to help gradually get out of the debt cycle, consider Tata Capital’s personal loan. We offer a sum of up to Rs. 35 lakh with a loan tenure of up to six years at the most reasonable rates to help our customers plan their credit better.
Policies, Codes & Other Documents