When to Downgrade a Card vs. When to Cancel

Just say no to useless cards.

I talk a lot about regularly auditing your credit cards. As our lives and financial needs change, so should our credit cards. But what are you supposed to do with those cards that don't make the cut?

For cards with no annual fee, the answer may simply be: nothing. Stick the card in a drawer and let it wallow. At best, you may find a use for it down the line. At worst, the issuer will cancel it for non-use and you saved yourself a phone call. (Just make sure to check it now and then for fraud or other anomalies.)

When the card is no longer worth its annual fee, however, something must be done. Because who wants to pay for a card that isn't pulling its weight?

In this case, you have two options: cancel -- or downgrade. Downgrading a card is when you switch it out for a card in the same family that has a lower annual fee. Why should you bother? Well, there are a few cases when it can be worth downgrading instead of canceling.

A credit line by any other name…

The most common reason people downgrade a card instead of cancel it is to hang on to the credit line. When you downgrade a credit card, you're changing the product type, but it usually keeps the same credit limit.

What's the benefit to this? It can be good for your credit score.

One of the big factors that goes into calculating your credit score is your credit utilization. This is the ratio of your credit card debt to your available credit. It's essentially a measure of how much of your potential credit you're actually using.

Credit scoring models look at your individual utilization rates -- that is, the utilization rate for each individual card -- but they also look at your overall utilization. So if your total available credit decreases (say, because you closed a credit card account), your overall utilization rate could rise. If you keep your credit line intact, it won't affect your utilization rate.

In general, utilization rate only matters if you carry balances. Folks who pay in full each month will have low to no utilization, so the reduced credit availability will have much less of an impact.

If you don't want to downgrade but still want to keep your credit line, you may be able to transfer it to another card from the same issuer. Not all issuers will let you do this, but it may be worth a call into customer service to see if it's an option.

Good rewards, bad fee

Another reason to downgrade your unused cards is if the less-expensive card product offers some of the same rewards or perks. This can let you still enjoy a rewards card, but without the high fee.

For example, say you're paying $95 a year for a card that earns 4% cash back on groceries, but there's a card in the same card family that earns 3% back and has no annual fee. You may not get enough out of the $95 card to make it worth the fee, but you may still want to earn grocery rewards. In this case, downgrading to the no annual fee card could be a perfect solution.

Whether this is a good option will of course depend on the specific card options. Make sure to do the math to see if the new card will really fit into your rewards maximization strategy.

No bonuses for downgrades

While downgrading can be a great way to cut the fee without losing your credit line or rewards, it isn't always the right move. For one thing, it's not always available. Some cards simply don't have downgrade paths.

The biggest downside, however, is that downgrading a card generally won't earn you a sign-up bonus. As such, you'll miss out on any sign-up bonus offered by the card to which you may downgrade.

While low- or no-fee cards tend to have smaller bonuses than their more expensive siblings, these bonuses can still be valuable. You'll need to decide if forgoing the bonus is worth it if you decide to downgrade.

That being said, canceling a card can also impact your ability to earn a sign-up bonus for that card or other cards in its family. Many issuers now have rules that limit whether you can earn a bonus based on when you last opened or closed a card in that family.

In the end, the decision of cancel vs. downgrade is very specific to your own needs and wants. Regardless of what you choose, remember that getting rid of an expensive card is almost always better than paying for a card you're not using.