When you close an account with a balance, you won’t have to pay a raised annual fee or APR should the issuer raise them, but you must keep making payments until the balance is paid off.
You can indeed close a credit card that still has a balance, but it’s crucial that you make payments – at least the minimum – until the card is paid off.
One of the most important factors of your credit score is credit utilization, or how much of your available credit you have used. This factor is second only to payment history in importance to your FICO score. For VantageScore, this factor is weighted even heavier – VantageScore refers to it as “extremely influential.” Even if an account has been closed, credit utilization (along with the other factors that make up your credit score) still comes into play.
What happens to your balance after you close a credit card?
When you close a credit card that has a balance, that balance doesn’t just go away – you still have to pay it off. Keep in mind that interest will keep accruing, so it’s a good idea to pay more than the minimum each billing period.
In addition, when you close a card, it will ding your credit score, particularly if you’ve had the card for a long time. Closing a long-time card will shorten your average credit age, which counts for 15% of your FICO score. If you have other cards with balances on them, it could also increase your credit utilization, which counts for 30% of your FICO score. If you want to figure out your credit utilization ratio, use this handy calculator.
Last, should you close a card, keep in mind that you’ll likely lose any awards you’ve earned. Make sure you redeem those rewards before you close the account – and should you have a good amount of cash back to redeem, consider applying it to the balance on the card.
How a closed credit card with a balance impacts your credit score
When you close a card, it lowers the average age of your accounts on your credit report, which can ding your score – particularly if it’s an account you’ve had for quite a while.
Also, once an account is closed, any available credit on the account at the time of the closure is no longer accessible to you, and that, too, can affect your score. It might seem like a closed account is at 100% utilization since you no longer have access to the account. But it is not as simple as that.
Credit scoring is complicated
While the factors of credit scoring (payment history, credit utilization, credit age, credit mix, new credit) seem pretty straightforward, the science behind credit scoring is complicated. Credit scoring is all about assessing risk and predicting future default. How much risk is a new lender taking on when they accept you as a new customer?
Closed accounts are a case in point. Accounts are closed all the time for many different reasons and can be closed by either the lender or the user. For instance, a lender might close an account due to nonpayment or non-use, while a user might close an account because the terms are changed by the lender.
So, rather than simply calling a closed account 100% utilized, the scoring algorithm will look at what the credit limit was at the time the account was closed because this will give a better assessment of risk, no matter why the account was closed. If your account had 80% of its credit line utilized when it was closed, the debt owed still represents a risk to any lender thinking of giving you new credit. So, it will score lower than if the balance was a smaller percentage of your limit.
Payment history counts, too
Credit utilization is not the only factor at play here. Payment history is the most influential factor in FICO scoring and is moderately influential in the VantageScore model. So, if the account was closed for nonpayment, for instance, that is going to heavily impact your credit score. The opposite is true if the account was closed by the user due to a change in terms – if payments were made on time and as agreed, that will be reflected in a positive way even though the account is now closed.
For many, though, accounts with a poor payment history are closed, and that is what causes the most damage to a credit score. Poor payment history is often the result of the credit card in question having a high interest rate, which makes it more difficult to keep up with. This is especially true if only minimum payments are made. While making minimum payments on time will help you avoid poor payment history, it won’t help you get out of debt.
Delinquent debts vs. charge-offs
A delinquent debt that hasn’t reached charge-off status (180 days late) and is paid becomes current on your credit report, but a charge-off never does. An unpaid charge-off becomes a paid charge-off if it hasn’t been sent to a third-party collector.
A paid charge-off is much better for your credit report than an unpaid charge-off because it indicates that, although you’ve had a serious problem, you eventually paid the bill. Everyone has a hard time at some point, but not everyone overcomes it and pays the bill. Once paid, you’ll get a boost on your credit report and you’ll find getting new credit at a reasonable rate easier.
Should you keep the credit card account open?
Before you decide to close or leave the account open, take the following things into consideration:
- You might want to keep it open if you’re planning to make a big purchase soon.
- If you’re planning to apply for more credit in the near future, it makes sense to leave it open.
- If you’re in a lot of debt already, keeping the card open could tempt you to take on more.
- If you’re paying a high annual fee and you’re not getting enough benefits from the card to offset that, it could be a smart move to close it.
If you decide to close the card, you can offset any impact it might have on your credit by paying off the balances on the other cards you hold. There are many ways to tackle credit card debt, including the avalanche and snowball methods and debt consolidation (one strategy for this could be taking out a balance transfer card).
Now that you know you will lose points for carrying debt on a closed card, have a plan in place to pay off the debt. This is especially important to do before you look to add new credit to your file. Applying for credit and generating a hard inquiry will ding your score temporarily. You don’t want to add insult to injury by applying too soon and being denied because a closed negative account is still dragging down your score.
The best way to avoid that is to take care of your outstanding debt and begin repairing your credit before you do anything else. And remember to apply for new credit only when you need to, not just because you can. This will help you in all areas of your credit, and your overall financial health.