As per creditcards, there are about 189 million American adults who have at least one (1) credit card. It has been a normal part of lives of people to have and use a credit card for at least every transaction. Yes it builds your credit score but what do people do that is wrong one way or another that can be considered as a money mistake?
Cancelling a credit card is easy. It is what most people think to “get out” of debt. However, that might not always be the case—it might be the biggest and the most financially impacting act a credit card owner can do.
But why do people cancel their credit cards in the first place?
BankRate, a consumer financial services company that is famous for its utility, found out that the main reason why people cancel their credit cards are a variety of things:
- 36 percent said that they are not using their credit cards enough
- 40 percent said that they were able to pay off their debt
- 36 percent said the interest rate they were paying for was too high; and
- 28 percent said that the annual fee of their credit card/s was/were too expensive.
All of their reasons might be true and we are in no position to invalidate what their reasons are—hey, it’s their card and they do what they want to do with it. But why is it a money mistake?
Ted Rossman, a Bankrate Cards analyst, said that cancelling a credit card does not only give you a loss of a easy access cash, it also negatively impacts your credit score.
There’s really just one main reason that canceling a credit card hurts your credit score: It raises your credit utilization ratio. That’s credit you’re using divided by credit available to you.”
Moreover, Rossman explains that ideally speaking, you will and should keep this ratio below 30 percent. For example, you owe $1,000 and your total available credit is $5,000. It’s hitting the 30 percent idea and is actually pretty good.
However, if you cancel a credit card that has a $3,000 limit and you owe the same $1,000—this puts your utilization at 60 percent which is double than the recommended percentage.
But is it just fine to cancel a credit card?
Rossman notes that cancelling a credit card won’t actually have drastic effects on people’s lives. However, it could negatively affect a person’s credit utilization ratio.
To be clear, in most cases, canceling a credit card won’t have a drastic effect on your financial life. The worst-case scenario would be a cancellation that significantly raises your credit utilization ratio. I’d also recommend refraining from making any significant changes to your credit profile when you’re about to apply for a mortgage, auto loan or another type of credit.”
What is a credit utilization ratio?
The credit utilization ratio or sometimes called the credit utilization rate, is the amount that revolves the credit that people usually use divided by the total amount of revolving credit available.
This, simply, can be thought as the good score that a person is allowed to use depending on the allowed credit they have. In formula, it is how much you currently are owing divided by your official credit limit.
Rossman suggest to keep accounts open even if they are not being used anymore. Even if you are paying for an annual fee for a card, Rossman recommends a change in the product instead of cancelling it.
A product change or change of product is when you contact the credit card company or issuing bank to ask to downgrade one or more of your cards to a card that does not charge an annual fee. Doing this will allow you to keep your finances and budgeting at a reasonable position while still keeping your credit score high.
But what are the best reasons for me to cancel a credit card?
If you think that you are overspending and you really could not trust yourself with a credit card, maybe it’s really time to let go. If you can’t control yourself, then how do you think would you be able to control your credit score?
Another reason,according to Rossman is that if you held a joint account with a person and the way on how you can completely untangle yourselves is by cancelling a credit card—then do so.
Cancelling your credit card is not always the best avenue to go to. You might not know it but it might actually be the worst and biggest money mistake you could ever commit.