- Dave Ramsey suggests canceling credit cards as soon as you've paid off your balance.
- He doesn't believe the impact on your credit score matters.
- Listening to this advice could come back to haunt you with a lower credit score.
You could regret listening to this piece of financial advice.
Dave Ramsey is a well-known finance expert, and one of his biggest tips is to avoid debt. He not only suggests that you shouldn't borrow and pay interest, but he also believes you should not use credit cards at all.
Since Ramsey doesn't think credit cards are worth having, it's probably not surprising that he advises consumers to cancel their cards as soon as they've paid off the balance due on them. But, while he has indicated that closing down credit cards is a smart financial choice, this is actually really bad advice.
Here's what Ramsey has said about canceling credit cards
The issue of closing down credit cards has been addressed on the Ramsey Solutions blog. As the blog explains, it's not enough to just vow to stop using credit cards or even to cut up your cards so you can't easily use them any more.
"Just because you shred your cards and vow to never use them again, it doesn’t mean they’re gone -- you have to close the accounts too," the blog reads. Ramsey goes on to give tips about how to close down your account, including waiting until you've paid off your balance, then contacting your card issuer to shut the account down, and then getting confirmation in writing.
The blog acknowledges, however, that the general consensus among financial experts is that shutting down credit accounts is a bad idea. "Turns out, many people will try to tell you closing a credit card is the worst decision of your life. Don’t worry, that’s not even a tiny bit true," it reads.
Ramsey downplays the very valid reasons why closing down old cards is a bad idea, suggesting you should move forward with this financial move even though doing so could come back to haunt you.
Ramsey is wrong about closing down old credit cards
The big reason why most experts advise against closing old credit card accounts is because doing so can hurt your credit score. And Ramsey's blog acknowledges that this is an issue. "When you close your credit card account, your score will drop a little but only for a short period of time."
The reality, though, is that depending on your situation, closing down your old account may have a bigger impact than he suggests and the impact could be long-term.
See, your credit score is based on several factors. These include payment history, the average age of your accounts, the types of credit you have available to you, the amount of credit you use relative to how much is available to you, and inquiries which are placed on your credit report when you apply for new credit.
The impact of closing a credit card account
Closing down credit cards affects many of these key factors that determine your score. If you close down old accounts, the average age of your credit is going to be shorter and this hurts your score since a long track record of responsible borrowing is better. You'll stop developing a positive payment history once your card is no longer open, and eventually the card will drop off your credit report which means you'll lose the record of on-time payments made in the past.
Most importantly, your credit utilization ratio could be affected and this is the second most important factor in determining your score. To understand how, take a simple example.
Say you have two credit cards, each with a $1,000 limit, and you've charged $500 on one card and nothing on the other. If you close the account with a $0 balance, your credit utilization ratio is $500 used out of $1,000 available (50%) -- and a high utilization ratio hurts your score. But if you didn't close down your old account, your ratio would be $500 out of $2,000, which means you'd be using just 25% of available credit (anything over 30% drags your score down quite a bit).
The bottom line is, there is no reason to close down old credit cards and take a hit to your credit score that could be substantial. Even if you don't want to use your cards much anymore, you can charge one streaming service on them each month and set up automatic payments so you don't have to worry about debt but can continue building a credit record that can open doors for you in the future.
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