The Downsides of Closing a Credit Card When You Still Owe Money
Cancelling a credit card with a balance owing has two significant consequences. The first is that your monthly minimum payment arrangement is no longer valid – the full amount is due and payable immediately. In fact, the credit card company will not close an account when there is a balance owing. They may lower the limit to zero or block the account so that it can no longer be used for new charges or cash advances, but they will leave the account open so that payments can be applied. Once you’ve paid it off in full, then the credit card can be cancelled.
The second reason why you don’t want to cancel a credit card when you still owe money is for the sake of your credit rating. Dropping your limit to zero will significantly lower your credit score. Your score is responsive to how much of your available credit you’re using, both for any credit cards and overall with all of the credit accounts listed on your credit report.
For example, if you owe $3,500 on your credit card and it has a limit of $5,000, your credit utilization ratio is 70%. That is about the maximum where you want that ratio to be. However, when you cancel the credit card, you still owe the $3,500 but now your limit is zero. When you are over your credit limit, as you are when the limit is zero, that impacts your credit score negatively.
How Are Credit Scores Calculated in Canada?
Does Closing a Credit Card With a Zero Balance Affect Your Credit Score?
While this seems like it should be an easy question to answer with either yes or no, it’s not quite that simple. Closing a credit card with a zero balance will impact your credit score. Whether it hurts or helps your credit rating depends on where you stand. Anything you do that is credit related, even when you close a paid off credit card account, affects your credit score because the activity is reported to the 2 credit bureau companies in Canada, Equifax and TransUnion.
The impact might be brief, or it may last some time. Whether your score goes up by 10 or 50 points, or down by 30, no one can predict that with any amount of accuracy. That’s because the credit scoring system is a little different with each company (and yes, you have at least two credit scores) and the algorithms are proprietary. Equifax and TransUnion don’t explain exactly how their algorithms work so that consumers have less chance of manipulating the system.
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Beyond the movement of your credit score due to cancelling a credit card, your score will also be affected by a higher credit utilization ratio once the account is reported as closed. Overall, you still owe what you owe on all of your other credit products, but how much credit you have available to you has now decreased.
In addition, if you had that credit card for a long time and all of your other forms of credit are much newer, your credit file will reflect that. And furthermore, if that credit card was your only form of revolving credit (you don’t have a line of credit or other credit cards), once you pay off your other debts, there are no accounts keeping your credit file active. It will begin to age, and information will disappear, potentially leaving you with no credit history. The information on your credit report changes every month and good or bad, almost everything will drop off your report 6-7 years from the date of last activity. This means that both your positive payment history and the wise use of your credit, along with any difficulties you had over the years (e.g. late payments, over limit, or debts in collections), will all no longer be reported.
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Should You Cancel a Credit Card After You Pay It Off?
After you pay off a credit card it is up to you whether you want to cancel it or not. Keeping one credit card open with no balance owing is just fine, as long as you use it periodically to keep it active. Inactive accounts don’t get a monthly statement, so you’d be less likely to notice any fraudulent charges or irregular activity. In an attempt to hide information from you, if someone obtains your account details for the purposes of illegal activity, one of the first things they will do is attempt to change your address. That way you will not be notified right away about their activities with your account. It will take a number of months, until your account is well past due, before the real you is tracked down by a debt collector and notified about the current balance owing.
If you’ve worked hard to pay your credit card off and are afraid you’ll go back into debt if you start using it again, store the card in a safe place. Pre-authorize the monthly payment of one bill or subscription with a fixed amount to the card, and pay the credit card off when the bill arrives. This will keep the account active on your credit file. It will also help to build or rebuild your credit rating as you demonstrate your consistent payments and careful usage.
However, if you have several credit cards, cancelling the ones that are paid off and no longer used or needed, protects you from temptation spending. Also, if you plan to apply for a loan or mortgage within the next few years, only keeping the credit cards that you actually use is a good idea. Too much available credit will hinder your chances of borrowing more.
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Using Credit Cards Wisely
While it may sound like some of the information about credit ratings and cancelling credit cards conflicts, it really boils down to using credit wisely and within a budget. Here are quick answers to 2 more questions you may have:
Do credit card companies like it when you pay in full every month?
Absolutely. They still make money even if you don’t pay them any interest, and they value a client who keeps their account in good standing.
Is it true that the only way to improve your credit score is to pay off your entire balance every month?
Several factors influence a credit score. Making your payments on time every month is one of the most important factors, and periodically making only a minimum payment won’t hurt your score. Only paying the minimum over a longer period of time and still using the card for more purchases won’t bring your overall balance owing down. That will eventually impact your score negatively.
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Get Help If You Are Trying to Escape the Credit Card Trap by Cancelling Your Cards
Consumer debt is at an all-time high and many Canadians are really worried about how they’ll manage what they owe. If you feel like you’re trapped by your credit card debt and want to cancel your cards and get rid of what you owe, we’re here to help. Unfortunately, you can’t just stop paying your credit cards, but no matter how bad you think your circumstances are, there are ways to get debt relief. Reach out to us before your situation gets worse, or if you just need some help to get yourself on track. We’ll provide you with information, guidance, and real solutions so that one day soon, you can take a day off work and not fret about your money problems.