Canceling a credit card may actually lower your credit score because the company that calculates credit scores takes into account the ratio of your total credit card debt over the total available credit that is given to you. This value is known as the credit utilization ratio and the higher it is, the lower your credit score will be.
Let us consider an example to make the situation more understandable. Let us assume that you have 10 credit cards with a limit of $3,000 each. This will mean that your total available credit is $30,000. Let us now assume that you have accumulated a credit card debt of $8,000. This means that your credit utilization ratio would be $8,000 divided by $30,000 or 26.67 percent. This ratio appears to acceptable based on the standards applied by most banks and lenders.
However, let us now consider the situation where you want to cancel five of your credit cards. This will have the effect of reducing your total available credit to $15,000. This will double your credit utilization ratio from 26.67 percent to 53.33 percent. This is now a value that is not acceptable to lenders and your credit score will suffer.
Based on the above calculations, we can see that canceling one card will only have a small effect. Thus, canceling a credit card that you do no actually use
may be a good idea. If you are having difficulties with managing and monitoring such a large number of credit cards, canceling even five of the 10 credit cards may still be a good idea if you have no plans of getting a home mortgage or any other loan in the future that would depend on your credit score. Also, if you employ your remaining five cards wisely, you may soon repair the damage that has been done to your credit score.
I can’t believe that people still can’t understand how credit works. Oops, neither does FICO!