Does Cancelling an Unused Credit Card Lower Your Credit Score in Canada?

Does Cancelling an Unused Credit Card Lower Your Credit Score in Canada?

Yes, cancelling an unused credit card can often lower your credit score in Canada, though the extent of the impact depends on several factors specific to your credit profile. The primary reasons for a potential drop are a reduction in your total available credit, which can increase your credit utilization ratio, and the shortening of your average credit history length, especially if the card is an older one. While it might seem logical to close accounts you don't use, doing so without understanding the implications can inadvertently hurt your financial standing.

Why People Consider Cancelling Credit Cards

Many Canadians consider cancelling credit cards for various reasons. Perhaps you have an old card from a bank you no longer use, a store card that no longer offers benefits, or you're simply trying to simplify your finances. Common motivations include:

• Annual Fees: Paying for a card you rarely or never use can feel like a waste of money.
• Too Many Cards: Managing multiple cards can be cumbersome and lead to overspending for some individuals.
• Security Concerns: Fewer cards mean fewer opportunities for fraud or identity theft.
• Simplification: Streamlining finances by reducing the number of accounts to track.
• Avoidance of Temptation: Removing access to credit if you struggle with spending.

How Your Credit Score is Calculated in Canada

To understand the impact of cancelling a card, it's crucial to know how credit scores are generally calculated by major credit bureaus like Equifax and TransUnion in Canada. While the exact algorithms are proprietary, they typically weigh the following factors:

• Payment History (approx. 35%): Your record of paying bills on time is the most critical factor. Missed or late payments significantly hurt your score.
• Amounts Owed (Credit Utilization) (approx. 30%): This refers to how much credit you're using compared to your total available credit. A lower utilization ratio is better.
• Length of Credit History (approx. 15%): The longer your accounts have been open and in good standing, the better. Older accounts demonstrate a longer track record of responsible borrowing.
• New Credit (approx. 10%): The number of recent credit inquiries and new accounts opened. Too many in a short period can signal risk.
• Credit Mix (approx. 10%): Having a healthy mix of different credit types (e.g., credit cards, lines of credit, loans, mortgage) can be seen as positive.

The Direct Impact of Cancelling a Card on Your Score

1. Credit Utilization Ratio (Amounts Owed)

This is often the most significant and immediate impact. Your credit utilization ratio is calculated by dividing your total outstanding balances by your total available credit limit across all your credit accounts. For example:

Imagine you have two credit cards: Card A with a $5,000 limit and a $1,000 balance, and Card B with a $5,000 limit and a $0 balance. Your total available credit is $10,000 ($5,000 + $5,000), and your total balance is $1,000. Your utilization ratio is $1,000 / $10,000 = 10%.

If you cancel Card B, your total available credit drops to $5,000. Now, your utilization ratio becomes $1,000 / $5,000 = 20%.

Even though your debt didn't change, your utilization doubled. Lenders generally prefer to see a utilization ratio below 30%, with anything below 10% considered excellent. A sudden increase in this ratio signals higher risk and can negatively affect your score.

2. Length of Credit History

The age of your credit accounts contributes to your credit score. When you close an older card, you effectively remove that account's age from your active credit file, which can shorten your average account age. For instance, if you have a 10-year-old card and a 2-year-old card, your average age is (10+2)/2 = 6 years. If you close the 10-year-old card, your average drops to just 2 years. This reduction in your credit history length can be detrimental, especially if you don't have many other long-standing accounts.

It's important to note that a closed account typically remains on your credit report for a period (e.g., 7-10 years in Canada), and its payment history continues to contribute to your score during that time. However, it will no longer contribute to your available credit or the calculation of the average age of open accounts.

3. Credit Mix

If the card you close is your only credit card and you primarily have installment loans (like a car loan), it could slightly impact your credit mix. However, for most people with multiple credit products, the impact on credit mix is usually minimal compared to utilization and history length.

When Cancelling a Card Might Be Less Harmful (or Even Beneficial)

While generally not recommended, there are specific scenarios where cancelling a credit card might have less negative impact or even a slight positive one:

• New Cards with Low Limits: If the card is relatively new (e.g., less than a year old) and has a very low credit limit, its removal might have a negligible impact on your average credit history and total available credit.
• Annual Fees for Unused Benefits: If you're paying an annual fee for a card you never use and whose benefits you don't leverage, the financial cost might outweigh the minor credit score hit. Consider downgrading to a no-fee version of the card first.
• Cards with a History of Missed Payments: While closing an account with a poor payment history won't remove the negative marks, it might help you break a cycle of bad financial habits associated with that particular card. However, the existing negative history will remain on your report for several years.
• Too Many Cards Making Management Difficult: If you're overwhelmed by too many credit cards and struggle to manage them responsibly, reducing their number might prevent future late payments or overspending, which would hurt your score far more than closing an account.

Alternatives to Cancelling an Unused Card

Before you decide to cut up that old card, consider these alternatives to maintain or even improve your credit score:

1. Downgrade to a No-Fee Card: Many banks allow you to switch your existing credit card to a different product within their portfolio, often to a no-annual-fee version. This keeps the account open, preserves its age, and maintains your credit limit without costing you money.
2. Use It Sporadically: Make a small purchase on the card every few months (e.g., gas, groceries, a streaming service subscription) and pay it off immediately. This keeps the account active and demonstrates responsible use.
3. Keep It for Emergencies: If it's a no-fee card, you can simply put it in a safe place and save it for genuine emergencies. Its available credit will continue to contribute positively to your utilization ratio.
4. Transfer Credit Limits (Rare): In some cases, if you have multiple cards with the same issuer, they might allow you to transfer a portion of the credit limit from the card you want to close to another card you wish to keep. This helps preserve your overall available credit.

Practical Tips Before Taking Action

If you are still considering closing an unused credit card, here are some practical steps and considerations:

• Check Your Credit Report: Obtain a free copy of your credit report from Equifax and TransUnion in Canada. Review all your accounts, their ages, and limits. This will give you a clear picture of what you stand to lose.
• Evaluate the Card's Age and Limit: Prioritize keeping your oldest cards, especially those with high limits, as they contribute most positively to your credit history length and utilization. If the card is young and has a low limit, the impact of closing it might be less severe.
• Pay Off All Balances: Ensure the card has a zero balance before closing it. This prevents any lingering debt from being sent to collections.
• Monitor Your Credit Score: After closing the card, keep an eye on your credit score for a few months. Services like Credit Karma or your bank might offer free credit monitoring.
• Understand the Long-Term Effects: While the immediate drop might be small, the long-term impact of shortening your credit history can be more significant, especially if you plan to apply for a major loan (like a mortgage) in the future.
• Consider Your Overall Credit Health: If you have a robust credit history with many other long-standing accounts and low utilization on all of them, the impact of closing one card might be minimal. If your credit profile is thin or already struggling, be much more cautious.

Conclusion

In conclusion, while it might seem counterintuitive, cancelling an unused credit card in Canada can indeed lower your credit score. The most significant factors at play are your credit utilization ratio and the length of your credit history. Before you close any account, carefully assess its age, its credit limit, and its role within your overall credit portfolio. Often, alternatives like downgrading to a no-fee card or making infrequent small purchases can achieve your goal of simplification without negatively impacting your credit score. Always prioritize maintaining a long, positive credit history and a low credit utilization ratio to ensure your financial health remains strong.