A credit card product change is a good way to get out of paying an annual fee, and it may be the right move if you own a travel rewards card in the COVID-19 era.
That’s when you switch to a different card from the same issuer (in this case, one that does not charge an annual fee). A product change is much better from a credit score standpoint than canceling the card. That’s because it keeps your credit line and preserves your credit utilization ratio, which is a key factor in determining your score.
Credit utilization is a fancy way of saying credit you’re using divided by credit available to you. It’s part of “how much you owe,” the category that comprises 30% of your FICO score. Only payment history (35%) is more important.
See related: How I’m spending differently during the pandemic
How canceling a credit card affects your credit score
Let’s say you owe $3,000 across your various credit cards and you have a total credit limit of $10,000. Your credit utilization ratio is 30% ($3,000 divided by $10,000), which is pretty good. But if you cancel a card with a $5,000 limit and still owe that same $3,000, now your credit utilization ratio is 60% ($3,000 divided by $5,000), which looks a lot worse to the credit bureaus.
In short, you should keep the available credit but lose the annual fee if you’re not getting value from that card.
(By the way, the major credit bureaus announced earlier this week that consumers can download their credit reports for free on a weekly basis for the next 12 months, so make sure to visit AnnualCreditReport.com to see where you stand.)
Product changes are about more than credit scores
Most credit cards that charge annual fees focus on travel rewards (for example, free flights and hotel stays) and other travel perks (such as airport lounge access and fee waivers for Global Entry and TSA Precheck). Due to the COVID-19 pandemic, travel has ground to a halt and most cardholders are unable to take advantage of these benefits.
Some card issuers have begun adapting their programs to compensate. For instance, the popular Chase Sapphire Reserve card is offering a one-time $100 credit to partially offset its $550 annual fee for cardholders with renewal dates between April 1 and July 1, 2020.
Capital One recently started allowing many of its cardholders to redeem miles for food delivery, takeout, streaming and phone services at the same elevated ratio as travel purchases. American Express is offering a 20% discount when select cardholders redeem Membership Rewards points at Amazon.com. And several major hotel chains are extending their free night awards into 2021.
All of this is a good start, but I think consumers will soon clamor for more. Many household budgets are being strained by unemployment – as evidenced by the more than 25 million initial jobless claims that were filed between March 15 and April 18 – so people are prioritizing near-term cash flow. You can typically get a prorated annual fee refund if you downgrade or cancel your card midyear.
Plus, travel is likely to be one of the last industries to recover. After 9/11, it took three years for airline capacity to recover, six years for airlines to regain profitability and eight years for the average fare to revisit its precrisis level. Marriott CEO Arne Sorenson said last month that the coronavirus has hit his company’s business harder than 9/11 and the financial crisis combined.
Without a widespread vaccine, or at least major strides in testing and treatment, it’s hard to see passengers clamoring to get on planes, trains and cruise ships anytime soon. Leisure and \business travel will likely be constrained by health and cost concerns for at least a year, and business travel might be forever changed now that videoconferencing has become more mainstream and could replace many in-person gatherings even after the COVID-19 threat passes.
In the credit card industry, these developments are combining to place a higher priority on no-annual-fee cash back cards, especially since those typically do a better job of maximizing spending on consumer staples.
Credit card lending standards have tightened considerably as the economic effects of the pandemic have spread, making new cards hard to obtain. A product change is an ideal way for cardholders to slip in the back door, eliminating an annual fee and optimizing their new spending habits.
Have a question about credit cards? Email me at email@example.com and I’d be happy to help.