Q: I've finally paid off almost $9,000 in debt on three credit cards. One of them has an outrageous APR of about 30%. I would like to cut this card out of my life and not let it be a reminder of my struggle with debt. But people keep telling me that it is a bad idea to close the card. Should I do it? And when should I do it?
- Peter K.
A: First off, congratulations on accomplishing such a financial endeavor!
Before you actually close your credit card, consider the effects that this will have on your credit scores.
Despite lack of a clear-cut explanation from credit scoring agencies, it is general knowledge that having your credit accounts for longer periods of time will help improve your credit scores. Although an account's history is not deleted when you shut down a credit card account, the account's age stops increasing.
Additionally, closing a credit card account will mean that you lose access to that credit limit, which has a negative impact on your credit score. Part of the credit scoring calculation takes into account your debt utilization ratio, or how much combined debt you have compared to the total combined credit limit.
Let's say Card A and Card B each have $5,000 credit limits, while Card C has a $10,000 credit limit -- for a total combined credit limit of $20,000. With credit card debt of $2,000, your debt utilization ratio is 10 percent. If you closed Card C, and held card debt of $2,000, your debt utilization ratio would increase to 20 percent.
Since having a lower debt utilization ratio is better, closing a credit card will have a negative impact on your credit scores. However, if you have absolutely no debt, the "ding" may be temporary.
If you are about to apply for a major loan, such as a mortgage, it would be best to hold onto the credit card and keep it at a $0 balance. This way, you don't cause your credit scores to drop right before you apply for the loan.
If you are at least one year away from applying for a big loan, you should be fine with closing the credit card. You will see a minor dip in your credit score but it should soon recover. The exception would be a credit card with a long history -- closing such an account could lead to a much bigger drop in your credit score. But, don't let this prevent you from closing the account if you truly believe it is hindering you from achieving financial independence.
Simon Zhen is an analyst, staff writer and columnist for MyBankTracker.com. His columns draw focus to all aspects of personal finance and to bank rates, products, and services.