With the way the cost of living has skyrocketed in recent times and the high-interest rates on credit accounts, it is not surprising that lots of people are considering closing their credit accounts as a strategy to limit their debts and improve their financial well being.
A credit account is an account that allows you to make purchases of goods and services when you don’t have the money to pay at the moment. Instead of paying with cash or debit card, you pay with a credit card, settling the retailer/service provider at the moment, and having to pay back the financial institution that offered you the credit card on a later date at an agreed interest rate. Depending on the credit account term, the repayment of principal and interest could be a lump sum or in installments.
The credit account makes it possible for you to make a purchase even while you are not liquid enough for the purchase. However, people sometimes find themselves contemplating closing their credit accounts over factors like high-interest rates and other accrued charges on the account, as well as the high standard of living amongst other reasons. While this decision may seem to be a smart one to take, it may also be ill-advised.
Why do people close their credit accounts?
There are numerous reasons people may choose to close their credit accounts. However, some of the popular reasons are;
To curb uncontrollable spending
If you discover that the presence of a credit account card in your wallet increases the temptation of becoming a spendthrift in you, you may start contemplating the credit account.
Some people are not disciplined enough to stick to spending on essentials while shopping with a credit card. They see access to a credit account as an opportunity to go on a shopping spree. They, therefore, believe that outrightly closing the credit account limits their irresponsibility and limits their expenses to what they have.
When the credit card is inactive
People also consider closing their credit account when they figured that they don’t really need it and the credit card is just lying idle with them. This decision becomes easier to make when such an account/card attracts an annual fee- irrespective of whether it’s used or not.
Understandably, you may feel a credit account is no longer necessary if you have been able to master the art of limiting your expenses to your raw cash or what you have in a debit card account despite owning a credit account. In such a scenario, the credit account is believed to not be necessary.
To protect themselves against identity theft
This is another reason why some people choose to close their credit accounts. They believe that through the credit card, they stand the risks of having their identity and details in the hand of fraudsters especially if they lose the card.
The continuous growth and innovation in technology have made this claim a valid one. Even though, banks are also evolving with the trend and improving on the safety of their customers the same way hackers are also working round the clock, seeking for loopholes to capitalize on and attack unsuspecting people and organizations.
When the interest rates are becoming unbearable
This is probably one of the major reasons people close their credit accounts. When the interest rate is becoming too much for them to pay, they begin to consider closing the account.
Most times, these people have other debts to clear and are willing to reduce their debt profile to as minimal as possible. So, they consider the debt from the credit account as one they need to weed out since the interest rates on it are becoming ridiculously high.
When partners operating joint credit accounts are separating
Business and romantic relationships go south and, in the process, account issues are sorted out especially when they are joint.
When partners jointly own a credit account and are about parting ways, they may consider closing the joint credit account as it may no longer be needed by either or both parties.
How does closing your credit account affect your credit score?
It is generally believed that closing a credit account is not always the best approach to combating all the financial challenges identified above and more. This is because that singular act is capable of affecting your credit score; which is not good at all. For some people, their great credit score is a result of their credit utilization ratio which involves their credit history and the current state of their balance as against their credit limit.
Your credit utilization ratio gulps 30% of your 3-digit FICO (formerlly known as Fair Isaac Corporation) score and your available credit is an integral part of it. Therefore, closing a credit account amounts to reducing the amount of credit to your name. This shoots your credit utilization ratio up and draws your credit score down.
Closing a credit account especially when it is your oldest may not be the best decision to make. It is even more dangerous to your credit score if you have other credit accounts and have been irresponsible with them.
Although, if you have been responsible with your handling of other credit accounts by making prompt payments as at when due and striving to maintain a low credit utilization ratio, your credit score would probably do fine.
Your credit history length also accounts for 15% of your FICO score. So, you may want to consider this before closing an old credit account, noting that the history on that account may contribute to boosting your credit score.
Why you shouldn’t close your credit account?
It is imperative to state that closing a credit account does not amount to your credit score automatically going to the negative. However, here are some cases where closing the account may not be advisable;
- Your credit score is sitting on the edge of what is called a good credit range and you don’t want to risk the possibility of dropping into the fair credit range over the change that closing a credit account can bring.
Just like a student calculating his/her CGPA, it sometimes takes a little drop of grade to drop from first-class to second-class upper and second-class lower as the case may be. Similarly, the little deduction in your credit score from the closure of a credit account may have an adverse effect on the same, especially if it is just at the edge of being regarded as a good credit score.
According to FICO’s scale, a good score ranges from 670 and 739, while 580 to 669 is considered fair. So, someone one 672 for example, will drop deep into the fair credit range if he/she decides to close an old credit account.
- If you have plans to apply for a mortgage, you may want to reconsider your decision to close a credit account.
Your credit score grossly affects your possibility of landing a mortgage for yourself. Therefore, dropping a credit score may not be a good thing for you. This is especially important considering the importance and necessity of a shelter for you.
- The credit account in question is your longest standing credit account. Just as stated earlier, this may not be a nice approach as such an account probably accounts for your highest credit history. Therefore, closing the same account may have you risking the possibility of shortening your credit history length and grossly affecting your credit score.
- When you run multiple credit accounts with huge outstanding balances and closing one will reduce your available credit to the extent where it affects your credit utilization ratio negatively.
For your credit utilization ratio, the more credit balance you have, the better your score. Therefore, reducing your available balance by closing a credit account has the tendency of negatively affecting your ratio immediately and your credit score ultimately.
- When your only reason is that you don’t use the credit account as often as other accounts. This is as good as not having a concrete reason whatsoever, other than the fact that it is not being put to use as frequently as it ought to.
An unused credit account may seem insignificant until you discover that it is contributing a lot to your credit score. Therefore, you may want to consider keeping it running.
- If that is your only credit source. If you don’t own multiple credit accounts like some people, you may want to think harder before deciding to close the only credit account that you have.
Closing the singular credit account that you have may not be the best thing to do. Aside from its ability to grossly affect your credit score, you may lose the liquidity it offers while you had it.
Alternatives to closing a credit account
If for whatever reason, you decide that you don’t want to run a credit account again and also don’t want the perks of having one open, you may want to consider the following options;
- Request for a product change. Most financial institutions have different products/services to satisfy different customers. Therefore, the problem may be with the product being offered to you.
If your credit account charges you annually, for example, you can ask to be migrated to a lower class of account that doesn’t attract annual fees. Depending on what you want, they may also offer you a product that charges less.
- Upgrade to the use of an unsecured card. If your credit account uses a secured card, instead of closing it, you may request to be upgraded to an unsecured credit card. For some institutions, they automatically upgrade you after you have proven to be responsible with the account over a certain period. If your service provider does not upgrade you automatically, you may ask for it to be done manually or enquire on how to earn an upgrade and enjoy the perks of the same.
iii. Use the account for small regular payments. You may decide to use the account for small but recurring expenses like your monthly cable subscription and set it to be done automatically on a particular date of the month. This way, you can ensure that you use the account frequently, not spending much and in a seamless process.
Also, ensure that you do not forget to refund these ‘small expenses’. Remember the impact of the account on your credit score. Therefore, as you use it for those little expenses, ensure you pay back as at when due.
- Instead of closing the credit account, be intentional to be disciplined about your spending. If you believe that the existence of the credit account is the reason you spend recklessly, watch out for your spending.
You can keep the credit card away from a place where you can get it easily, stick to your budget when shopping, freeze the credit card in a block of ice (yes, you can), or in severe cases, instruct your issuer to pause transactions on the credit account. That way, the account exists but is inactive for the time being, pending when you are able to be on top of your spending.
Generally, your credit score is an important aspect of your financial life and should not be taken lightly. Whatever action you choose to take on your credit account, your credit score must be at the top of considerations for such an act. Anything that will negatively affect your credit score and credit history may not be the best for you ultimately. They are capable of depriving you of juicy and life-changing financial opportunities in the future.
If you still want to close your credit account, do well to take a vivid look at your current credit score, consider the effect of that act on the same, and decide if you still want to go ahead with it. The overall plan is to be financially independent and progressive at the end of the day, using the most favorable and informed approach.