When you work diligently to pay off a credit card, nothing is more satisfying than seeing the balance hit $0. It’s a eureka moment – filled with accomplishment and freedom. And your next desire may be to shred the credit card and close the account. But is that the right move?

What you do next really depends on your spending habits – or better put, your ability not to spend.

Closing the credit account could negatively impact your credit score. But keeping it open may tempt you to spend more and fall back into debt. Let’s review both options so that you can make the best decision for you and your finances.

When You Should Close Your Credit Account

The case for closing your credit card comes down to one thing – temptation. If you find it challenging to resist using your credit card, the wise decision will be to close the account.

Yes, closing the card may negatively affect your credit score a bit. However, a slight drop in your score is much better than accumulating more debt you have to repay – especially if it’s debt you cannot repay quickly.

If you want some extra guidance about your personal finances or need some help managing your debt, you can always schedule an appointment with the Roanoke Financial Empowerment Center - at no cost to you. These professionally-trained counselors will work with you one-on-one free of judgment to answer your financial questions and help you achieve your goals.

Why You Should Keep Your Credit Account Open

Credit scores can be tricky and often seem backward. To build a good credit score, you need to have credit available to you – and then prove you can manage that credit responsibly.

Made up of five main factors, credit scores encompass:

• Payment History
• Amount Owed
• Length of Credit
• Credit Mix
• New Credit & Inquiries

We'll go into more detail about how credit scores work below, but before we do - did you know that Freedom First members can check their credit score at any time in online/mobile banking for free and with no impact to their score?

This tool helps you understand your credit report and even lets you run simulations on how your score could change based on different actions you take. Log in to your online or mobile banking to get started, or learn more here:

Closing a credit card can lead to changes in certain areas of your credit report, possibly causing your score to decline. To illustrate how this works, review the following scenarios.

Credit Utilization Ratio

Before approving any loan, one of the first things a lender will do is calculate your credit utilization ratio (CUR). This is a representation of how much you have spent from your available credit. For example, if you have spent $3,000 on a credit card with a limit of $10,000, your CUR will be 30%.

Lenders typically want this ratio to be below 30% as it demonstrates you’re able to manage credit effectively.

So how does closing a credit card affect your CUR? See for yourself.

Assume you have three credit cards with various balances and limits.

Between the three credit cards, your total balance is $2,500 ($500 + $1,500 + $500). Your total available credit limit is $8,500 ($5,000 + $2,500 + $1,000). In this example, your credit utilization ratio would be 29%, which is good.

But what if you pay off Credit Card A and close the account?

Your total balance will now be $2,000 ($1,500 + $500), with a total credit limit of $3,500 ($2,500 + $1,000). As a result, your CUR will now jump significantly to 57%! Remember, lenders like to see this ratio below 30%.

Length of Credit

When it comes to planning for retirement, most people focus on saving as much as possible and straightforward diversification strategies. However, one of the most commonly overlooked aspects of retirement planning is taxes.

No matter how much you save, Uncle Sam will always find a way to take his cut. Even if you do not have significant funds to save right now, there are steps you can take to maximize the value of your investments. Whether through tax-advantaged accounts (IRAs) or Health Savings Accounts (HSAs), finding ways to avoid higher taxes in the future should be a top priority of every investor.

Credit Mix

Your credit score comprises a mix of credit accounts, such as credit cards, auto loans, student loans, and home loans. Maintaining a variety of credit types helps to improve your credit score. It also shows lenders you are experienced and capable of managing different kinds of debt.

If the credit card you are considering closing is your only credit card, it can affect your overall credit mix – possibly leading to a decline in your score.

Takeaway

Closing a credit card once your balance is paid in full is a great strategy if it’s challenging for you to avoid using the card. However, if you can manage the card and avoid the temptation of using it, keeping the card active is wise and will help build your credit score.

To keep your credit card active, you do need to use it. One of the best ways to accomplish this is by using the credit card to fill up your gas tank once a month. Immediately repay the balance and avoid using the card again – unless for financial emergencies.

We’re Here to Help!

Learning to manage credit and build your score takes time, patience, and an understanding of how credit scores work. Our Financial Empowerment Center is here to answer all your questions and help you determine what financial decisions are right for you. You can also call us or visit your nearest branch anytime and we'll be happy to answer your questions!