Canceling a card can hurt your credit score

When rates and fees rise, consider your credit score before canceling card

Question for the expert

Dear Credit Score Report,
I've had a Citi card since 1994. I hardly ever use it and now they want to start charging an annual fee of $60. I want to cancel. Will this affect my credit score? Can they cancel me? And would that affect my score? Please advise. Thank you. -- Ann

Answer for the expert

Hey Ann,
Closing an existing credit card account -- whether you choose to or are forced to -- could potentially mean a drop in your credit score, though you can lessen that possibility by not carrying a balance and keeping up good credit habits.

You certainly aren't the only cardholder forced to choose between higher costs or the possibility of a lower credit score.  In response to economic challenges and the Credit CARD Act's customer-friendly reforms, a number of banks have sought  new sources of income, including charging customers higher interest rates and fees. Among those major issuers, Citi recently informed select cardholders that, starting April 1, they will be charged a $60 annual fee, to be refunded if the customer charges a minimum of $2,400 during the year. As a member of this unlucky group, Ann, you can avoid that fee by either using your card more often or by closing the account. But whether you close the card or Citi does, your credit score could still fall.

If you decide to continue using your card, you'll need to increase your charges to get the fee refunded. "Customers have the opportunity to have the annual fee credited back to their account by using their cards for the purchases they may already make on a regular basis," says Citi spokesman Samuel Wang. Otherwise, if you fail to adequately use the card, that fee will stick.

Citi's new charge is a fee, and it is triggered by a type of inactivity -- not charging enough -- but Citi says it is not an "inactivity fee." Inactivity fees would be banned under rules proposed by the Federal Reserve and scheduled to go into effect in August 2010. Will Citi's variety of the fee be banned, too? "The proposal does not specifically address this situation, but we will be looking at it as we prepare a final rule," a Fed representative tells me. The Fed released its proposed rules early in March 2010, and is currently gathering public comments. It will finalize its rules in the next few months.

Your have the option to simply close your Citi card account. "As before, every customer has the choice to opt out and pay off the existing balances over time at their current rates and fees," Wang says. In August 2009, consumers gained the right to opt out of credit card changes under another portion of the same card reform law.

If you carry a balance, closing an account can alter your credit utilization (also known as a balance-to-limit ratio), which compares your card balances to the limits on those cards. That ratio is an important part of your FICO score's "amounts owed" category -- a segment that makes up 30 percent of your FICO score and a similar amount in other types of credit scores.   

Here's how it works: Imagine that you carry $2,000 in debt across several cards with a combined total of $10,000 in available credit lines. Then you decide to close that Citi card, which has a zero balance, but a $5,000 line of credit. That leaves you with half of your original available credit. As a result, your existing $2,000 in debt suddenly makes up a much larger portion of the $5,000 in credit you still have available -- impacting your credit utilization and potentially your credit score along with it. If your credit score falls, expect it to become more difficult and costly to borrow money. Of course, if you don't carry a balance, the utilization ratio remains zero, and you don't have to worry abut this.

Improving your credit history can diminish that damage. Start by looking over your credit reports for any negative items. If these items appear to be errors made by the banks or credit bureaus, get the mistakes erased from your report. On the other hand, if they accurately reflect credit mistakes, use these items as a guide to becoming a better borrower. That may include catching up on any late payments, reducing your outstanding debt and always paying bills on time from now on.  Any positive payment history on that Citi card, meanwhile, will remain on your credit report for 10 years, helping bolster your credit score for another decade. As time passes, you may also slowly open new cards as needed.

Over the years, as you continue to responsibly use your other accounts, they will age, enabling them to add further support to your credit history.

Good luck!

-- Jeremy

See related: A complete guide to the Credit CARD Act, Tips for keeping interest rates and fees low, How to cancel a credit card the right way, New proposed rules from Fed would ban credit card inactivity fees, 8 legit ways to improve your credit history, How to dispute credit report errors

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Updated: 12-12-2018