Should You Cancel Your Old Credit Cards in 2023?

The decision isn't as simple as you might think.

With 2023 just a few weeks away, you're probably ready for a fresh start. If you've made a New Year's resolution to work on your finances, you might be thinking it's time to shed those old financial products and habits that aren't serving you anymore. This can be a great first step, but it's important to think through all the consequences of your decision before you make any changes.

Take closing old credit cards, for example. There are situations where this can make a lot of sense, and there are other times where you might be better off leaving them open. Here's how to know which is which.

What happens when you cancel a credit card?

Canceling a credit card is pretty simple. You contact the credit card issuer and tell the representative you no longer want the credit card. Once it's canceled, you'll no longer be able to charge any items to the card, but you also won't receive any more bills, unless you have an outstanding balance.

It might not have any serious effects on your day-to-day finances, but it will affect your credit score thanks to something called the credit utilization ratio. This is one of the most significant factors affecting credit scores today. It's essentially the ratio between how much credit you have available to you each month and how much you're actually spending. For example, if you have a $2,000 balance on a card with a $10,000 limit, your credit utilization ratio for that card is 20%.

Lenders like to see an overall credit utilization ratio of under 30% -- and the lower, the better as long as it's above 0%. No credit utilization leaves lenders in the dark about how you'll manage borrowed money, and so lenders generally charge these individuals more in interest than they do people who have proven that they can borrow money and pay it back on time.

A credit utilization ratio exceeding 30% is also concerning for lenders because it indicates that the person has to borrow a lot of money to support their lifestyle. With this comes a greater risk of default, so lenders charge them higher interest rates.

Bringing this back to credit cards, when you close a credit card, you're eliminating its limit from your available credit and actually increasing your credit utilization ratio. Let's say you have the following cards:

• Card A: $10,000 limit with a $5,000 average monthly balance
• Card B: $5,000 limit with a $3,000 average monthly balance
• Card C: $15,000 limit with a $0 average monthly balance

You decide you don't really need Card C anymore because you don't use it, so you cancel it. But in doing so, you reduce your available credit from $30,000 to $15,000. And you raise your credit utilization ratio from about 27% to 53%. That's going to hurt your credit score.

When it makes sense to cancel a credit card

Despite the impact on your credit score, there are a few situations when canceling a credit card can still make sense.

When the card has an annual fee

Some credit cards charge annual fees that you'll pay as long as you own the card, regardless of how much you use it. These fees can sometimes cost hundreds of dollars per year, especially on some travel rewards cards. When you're using the card and earning enough rewards to offset the fee, paying it makes sense. But if you're not getting any benefit out of the card, it's to your advantage to cancel it and avoid its monthly charge.

If it tempts you to spend more than you should

Credit card debt isn't always a choice, but regardless of how it happens, it can create long-lasting financial challenges. For those who feel tempted to spend up to their card's limit just because they can, it might be beneficial to cancel unused cards to reduce this risk.

What to do if you decide to cancel a credit card

To cancel your credit card, all you need to do is notify your credit card issuer of your decision and follow the instructions. But first, you should make sure you don't have any recurring bill payments set up using that card. If you do, switch them to another card first. It's also a good idea to check if you have any unused rewards on the card you plan to cancel. If so, try to use them up. You'll lose access to these once you cancel the card.

Try to limit yourself to one card cancellation every six months or so to minimize the effect that this has on your credit score. And if you think you're eligible for one, consider requesting a credit limit increase on one of your other cards to offset some of the negative effects of canceling your credit card. If that doesn't work, stay mindful of how much you're spending and do your best to keep your credit utilization ratio under 30%.