Do you have a few old credit cards you don't really use anymore? Or is your credit card company raising your annual fee or cutting perks?
The decision to close a credit card is one that should be considered carefully. Closing accounts can temporarily hurt your credit score due to the reduction in your total credit line, as well as reducing the age of your accounts, both of which I'll get into later.
Here are a few scenarios where it might do more good than harm to close your unwanted credit cards and move on with your financial life.
Do you plan on applying for credit anytime soon?
I list this first because if you anticipate applying for new credit anytime soon, such as a mortgage or a car loan, it's usually better to tough it out and hang on to your cards for the time being.
For starters, one of the largest components of the FICO credit scoring formula is "amounts owed" which makes up 30% of your score. Now, this doesn't refer to the actual dollar amount you owe on your accounts, but how much you owe relative to your total available credit line.
And most experts recommend keeping this amount below 30% at the absolute most. In other words, if you have $10,000 in combined credit limits, $3,000 is the absolute highest balance you should ever carry.
So, if you have $10,000 in credit limits with just $1,500 in balances, you are using 15% of your available credit. If you close a card with a $4,000 limit, your credit usage jumps to 25% even though you haven't bought a single thing. This will undoubtedly affect your credit score.
And, another 15% of your score comes from the length of your credit history. While your credit history starts when your oldest account did, even if it's closed, the average age of your active accounts plays a role in your score. So, if you close credit card accounts that have been open for a while, your credit score could get dinged for this reason as well.
Do you still have "starter cards"?
The number one type of cards you should get rid of, provided you don't need to apply for new credit anytime soon, are your "starter" cards.
These are credit cards with relatively low limits, like $500 or $1,000, which come with high interest rates and fees. Generally, people who have no yet established their credit apply for these, hence the term "starter cards". I've seen starter cards with interest rates of over 30% and annual fees of up to 25% of the credit limit, the highest allowed by law.
The major downside to getting rid of your starter cards is that they are generally your oldest active accounts on your credit report. Therefore, they can have the largest negative impact on the average age of your accounts, which I mentioned earlier was a factor in the FICO credit scoring formula.
Are your card's benefits no longer worth the cost?
Let's say that you got a credit card that gave you airline miles and other great travel benefits at a time when you were traveling frequently for business. Well, if a life change results in no more travel, maybe the card isn't worth keeping anymore.
For example, the Citi Platinum Aadvantage World MasterCard comes with such benefits as free checked bags, priority boarding, and a $100 American Airlines flight discount every year, which itself makes up for the $95 annual fee. However, if you're not traveling anymore, it can be hard to justify paying the fee every year, especially when many cash-back rewards cards are available with no annual fee whatsoever.
And, on the topic of annual fees, several credit card issuers have raised their fees lately in order to continue to offer competitive benefits. So, you should make sure that your benefits usage is worth the increased fee if this applies to you.
For example, the American Express Platinum Delta Sky Miles card recently increased its annual fee from $150 to $195. Now, if you take advantage of the card's benefits this can be well worth it. However, if you don't travel enough to take advantage of nearly $200 worth of free bags, priority boarding, and the card's other benefits, a rising fee could be a good reason to consider ditching the card.
It's all about you
Basically, no matter how good a card looks on paper, if it no longer works for you, it may be time to get rid of it.
And, if you decide to get rid of one (or more) of your credit cards, it is very important to do so at a time when you're not planning on applying for new credit anytime soon. The hit to your credit score when you close an account will be temporary, but it could be substantial at first.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends American Express and MasterCard. The Motley Fool owns shares of Citigroup and MasterCard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.