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TPG reader Richard sent me a message on Facebook to ask about managing his credit score:
“My travel has decreased significantly, and I’m thinking about canceling several hotel-branded cards with annual fees. Should I replace them with other cards that have no annual fee in order to maintain a low debt-to-credit ratio?”
Your debt-to-credit ratio (also known as your utilization ratio) is one of the more important factors that determine your credit score. It measures the outstanding balance on your accounts in relation to the total credit available to you, which helps lenders assess your capacity to take on new debt. Maintaining a low utilization ratio can improve your credit score, so it’s good to keep it in mind when you’re thinking about canceling a card.
To see how this works, suppose you have 10 cards that each have a credit line of $10,000 (for a total limit of $100,000). If your cumulative balance across those accounts is $5,000, then your utilization ratio is 5%. Canceling a card reduces your total credit limit (the denominator in the utilization ratio), but whether that has a meaningful impact depends on how many other accounts you have open and how much you use them.
Closing three cards in the example above would reduce your total limit from $100,000 to $70,000, increasing your utilization ratio from 5% to about 7%. That small increase isn’t likely to matter in the long run. On the other hand, if you started out with only four cards instead of ten, then canceling three of them would drop your total limit from $40,000 to $10,000. In turn, your utilization ratio would increase from 12.5% to 50%, which would almost certainly have a negative impact on your credit score.
There’s no universal answer here, but avoiding a high utilization ratio is certainly worthwhile. If you can close an account and maintain a ratio of less than 15%, then I wouldn’t worry too much about it. If closing an account pushes your ratio to around 15%-25%, then you should consider other options like downgrading your card to a no-fee version or replacing the old account with a new one as Richard suggested. I would be reluctant to close an account if doing so left me with a utilization ratio of more than 30%.
If you decide to swap your current accounts for other cards with no annual fee, I recommend that you apply for the new card before canceling the old one. That way, your existing credit line will still be factored into your score, so your utilization ratio will remain high while your application is being considered. Of course, new applications also impact your credit score, so be sure to take all the different factors into account.
For more info about when to cancel a credit card, check out these posts:
- My Credit Card Inventory: Which to Keep and Which to Cancel?
- Will My Credit Score Drop If I Don’t Use My Credit Cards?
- Should I Cancel a Credit Card If I Don’t Use It Anymore?
- Should I Reduce My High Credit Limit If I Don’t Use It?
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