5 reasons why you shouldn’t close your credit card

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It’s not at all unusual for people to close out a credit card after paying it off. But in most cases, it’s not the right thing to do. As hard as it is to believe, closing out a credit card can actually hurt your credit situation, much more so than it can help.

We’ll start with some reasons why you may not want to close the card out, and then I’ll explain how that can actually work against you.

The main reasons for closing out a credit card are usually personal, having to do with self-discipline and emotional factors.

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You don’t want to be tempted to use it

If you had a bad history with credit card use, getting rid of any cards you have can seems to make perfect sense. After all, what you don’t have, you won’t be tempted to use.

Image Credit: DepositPhotos.com.

Burying a bad experience

If you’ve had a bad experience with a certain credit card, you may equate the closing out of line as a way of putting the whole ugly episode behind you once and for all. It’s a way to bring closure to a bad experience.

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Getting revenge against the issuing bank

This may have been the result of disputed charges or very high interest rates. It may also have been that you went through a bad time when you couldn’t make the payments, and the bank refused to cooperate.

By closing out the account, it gives you a feeling of revenge against the bank. It denies them the opportunity to have your business – and the revenue that it will generate. That can make perfect sense, since we never want to do business with anyone who we feel has done us wrong.

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Eliminating an annual fee

This is the only truly practical reason for closing out a credit card. Since many cards come with annual fees, closing out a credit line will save you from paying that fee.

This can actually make sense if the fee is high, like at least $100 per year. It may also be an issue if you have several credit cards with no balances, and each charges you a fee. Five unused credit cards, each with a $50 annual fee, will cost you $250 per year. That could be a legitimate reason to close out one or more credit cards.

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Declaring total victory over your debt problem

Symbolically, this one can be significant. If you have been dealing with a debt problem for several years, closing out one of the offending credit cards could represent a declaration of your victory over the problem.

But while this may feel good, it is not necessarily the right course of action. Just knowing that you have paid off the card should be its own reward. Closing it out may be an exercise in over-kill.

Now let’s take a look at the reasons why leaving a credit card open can work in your favor.

Though it can seem counter intuitive to pay off a credit card and not close it out, modern finances have some complications that can actually mean that it is in your best interest to keep the card open.

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1. It will hurt your credit utilization ratio

Credit utilization is the second most important factor in computing your credit score. Payment history is number one, and represents 35% of your credit score calculation. But credit utilization is a close second, at 30%.

Your credit utilization ratio is determined by dividing the amount of outstanding credit, by the amount of credit lines that you have available. For example, if you have $20,000 in credit lines, and $10,000 in outstanding debt against those lines, your credit utilization ratio is 50% ($10,000 divided by 20,000).

In the credit scoring world, a good credit utilization ratio is usually 30% or less. To the degree that it exceeds 30%, it will have a negative impact on your credit score. And if it gets up around 90%, it will have a very negative impact, as that kind of ratio is considered to be an indication of potential default.

This is the primary reason one would want to keep open a credit card that has no balance on it. The card increases the amount of credit you have available, and that works to improve your credit score.

Using the example above, if you close out a credit card that has a credit limit of $5,000, that will reduce your available credit from $20,000 down to $15,000. If you owe $10,000 on those lines, your credit utilization ratio will instantly jump to 67% ($10,000 divided by $15,000). That will cause an immediate drop in your credit score.

For that reason, having a few credit cards open with zero balances is one of your best friends when it comes to your credit score.

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2. Your bad credit history on the card won’t disappear

It may be thought that by closing out a credit card, you also eliminate a bad credit history on it. But when it comes to credit reports, that’s not how it works. Whether your account is open or closed, the credit history on the card will remain on your credit for seven years. Closing the credit card will not make that go away.

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3. It won’t make the outstanding balance go away

Some people may believe that by closing out a credit card, their obligation to make payments on it goes away. That’s a completely mistaken belief. If you owe money on a credit card, you will owe it whether the card is open or closed. An unpaid balance on a closed account will end up as a collection account or even a judgment. And either could make your credit score even worse.

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4. Maintaining a strong credit mix

 Credit bureaus look for a balance between installment loans and revolving debt. Too much of either is considered to be a negative factor. Keeping open credit cards that have no balance can help offset high installment loan debts. If you have large car loans or student loans, you should keep this in mind.

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5. A few paid accounts looks really good on a credit report

The highest credit scores usually go to people who have a large number of paid accounts. For that reason, a paid credit line that is still open can be to your benefit.

Just as important, an open zero balance credit card will continue to appear on your credit report for as long as the account is open. But if you pay it off, it will disappear from your credit report after seven years. The goal then is to accumulate as many paid but open accounts as possible.

Though it can seem as if closing out the credit card is the right thing to do, it can actually end up being the absolute wrong course of action. If you have recently paid off credit card, celebrate your triumph, but protect your credit score by keeping the card open.

This article originally appeared on CreditPilgrim.com and was syndicated by MediaFeed.org.

Image Credit: DepositPhotos.com.

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