When refinancing, closing credit card accounts can cost you

Under some circumstances, it's wiser to just eat that annual fee

Question for the CreditCards.com expert

Dear Credit Score Report,
I just started paying attention to the new credit card laws. I will be paying off my credit card balance very soon with my income tax refund, but I am concerned now because I have had many credit cards over the years and never canceled them. I have NOT been reading or saving the stuff that they've been sending because I knew I wouldn't be using them. I've always tried to stay with a 0 percent interest card, so I've kept switching every six to 12 months. My credit score is 780, and I am working on refinancing my home. Now I am concerned that these old accounts may come back to bite me. Can they charge me annual fees if I have been inactive for a year or more? Should I cancel my old accounts? I don't even have the cards for most of them anymore. -- Melanie

Answer for the CreditCards.com expert

Hey Melanie,
While you're in the midst of a home refinancing, experts say it will probably cost you more to close those credit cards.  

Although your current credit score is pretty high, you certainly don't want it to fall during a time you're looking to borrow money. If you cancel credit cards, that's a very real possibility. That's because closing card accounts impacts a key credit scoring factor called a credit utilization ratio -- the amount of debt you have compared to your available credit. As your debt levels rise relative to your limits, your FICO score is likely to fall, potentially costing you thousands of dollars in interest charges when it comes to refinancing a home. That's probably much more than you'd pay for any annual fees or inactivity fees, which you say may or may not even apply to your cards. The only way to find that out is to contact your lenders and begin reading your mail.

When it comes to reading your mail, there's no time like the present to get started: With major pieces of the Credit CARD Act now in effect, banks are required to provide 45 days' notice about the addition of new fees, while also giving cardholders the option to decline the fees and pay off the account under its existing terms before closing the account. "This is a great example of why it is more important now to read your mail," says Peter Garuccio, spokesman for the American Bankers Association trade group.

How much do fees typically cost? According to the Chicago-based market research firm Mintel Comperemedia, the average annual fee listed in credit card mailing offers -- excluding private label retail and charge cards -- totaled $71.94 in January and February of this year, with 30 percent of those cards charging an annual fee. To learn the exact cost of your fees, you'll need to check with your issuers. If you no longer have the banks' letters, you'll have to contact the card issuers directly to find out about their fees. Also, be sure to ask about the balances and credit limits on those cards, which you should probably write down. Then you'll have a decision to make. "If those cards come with hefty annual fees, the consumer should carefully weigh which is more detrimental -- the potential impact to their credit scores or the money out-of-pocket for the fees. The answer to that question will depend on the level of fees and the individual's personal situation and preferences," says Rod Griffin, director of public education at credit bureau Experian.   

To predict the possible impact closing accounts will have on your credit, you'll need to consider two factors:   

  • Credit utilization, the ratio that compares your current balances to the combined limits on all your credit cards.
  • Length of credit history, which looks at the age of your accounts.

According to FICO, you need to be primarily concerned about the possible impact canceling cards could have on your credit utilization. That ratio accounts for a significant portion of the FICO score's "amounts owed" category, which itself makes up 30 percent of that score. Meanwhile, the length of your history wouldn't change for another decade, since positive information from closed accounts remains on your credit report for 10 years. The home refinancing process is unlikely to take that long.    

To help estimate the change in your utilization ratio, FICO recommends using your credit card account information to run a quick test. "Add up all of your limits and all of your balances -- including zeroes -- and look at percentage of available credit that you are using," says Barry Paperno, consumer operations manager at myFICO.com. Take away the cards you plan to close, and do that same calculation again. "By doing that exercise, you'll get an idea of what that's doing to your utilization," Paperno says. Depending on the increase in your utilization ratio, "you can expect a decline in your score, to some degree," he says. 

That decline could cost you real money. For example, a 100-point drop in your FICO score -- which someone with a 780 credit score might see if they're 30 days late with a payment -- will increase the APR you'd get for your next mortgage, costing you nearly $1,000 a year in mortgage payments. (This chart will give you an idea of how a lower FICO score can raise the cost your mortgage and other loans.)

To maintain or improve your credit score, consider the following suggestions:

Read your mail and keep any important letters. Looking at bank mailings will help you stay updated on the amount of your card balances, credit limits and any fees. "The CARD Act contains various new rights that card customers can now exercise (e.g., the right to opt-out of future interest rate increases), so reading your mail is more important these days," says Garuccio. He also suggests keeping a copy of your account agreement for future reference, or at least finding out where you can find that information online.   

Close cards with lower credit limits first. If you do decide to cancel some accounts, consider which ones have the highest credit limits and which have the lowest limits. When the time comes to choose which cards to close, Papierno says to leave open the ones with the highest available credit and close the ones with the lowest limits. That will protect your credit score from the most serious damage by preserving your credit utilization. Additionally, you may want request credit limit increases on any cards you keep open, although some experts caution these requests may result in account reviews that leave the borrower with even worse terms.

Check your credit report for errors. You can get a free copy of your credit reports from each of the three major bureaus once every 12 months. "Review the report carefully," says Experian's Griffin. "Dispute any information you believe is incorrect. If you find you have work to do to improve your credit score, use the report received with the score to help create an action plan," Griffin says.

Once that refinancing process is complete, you may be willing to see your FICO score drop temporarily in order to save money on fees. "If the person is not planning to apply for credit in the near future, credit scores are a far less important factor than the cost of keeping the card open," says Experian's Griffin. "Credit scores only become an issue if the person is applying for credit."   

Good luck!

-- Jeremy

See related: How to cancel a credit card, Credit card reform arrives in the form of the Credit CARD Act, A guide to the Credit CARD Act of 2009, Free credit reports: How to get the actual free one, Decade-old credit mistakes shouldn't appear on your report

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Updated: 03-26-2019