Cancelling your Credit Card might hurt your Credit Score

Cancelling your credit card seems to be a good choice if you want to lower your use of credit card and thus lower your debt accumulation. Fewer credit cards also means you can manage your financial life easier. However, with fewer credit card, it is not necessary better than having more especially when it comes to your credit score.

Before I begin with how cancelling your credit card may affect your credit score, I will first begin with why we need to have good credit score. Credit score is a number representing the creditworthiness of a person which means the likelihood of the person in paying back a loan. When you want to take a loan either for a house, a car or anything else, bank will evaluate you based on your credit score. Thus, people with good credit score will have a better chance to get their application approved rather than people with bad credit score.

Utilization Ratio
This is one of the factor that affects your credit score. This is the percentage between the total amount of your debt and available credit. This means that when you cancel your credit card, your available credit will be lower but your debt will stay the same thus increasing your ratio.

For example, you have two credit cards, both with RM 5,000 credit limits. You have a RM 2,000 balance on one of the cards, or about 20% of your total available credit. If you cancel the second card, you will then be using 40% of your available credit. It will increase your utilization ratio and damage your credit score.

However, this won't hurt your credit score forever. As soon as you reduce your credit card balances (or increase your credit limits), your ratio will decrease and your credit score improve.