In today’s world, credit cards have become an integral part of our financial lives. With the increasing prevalence of credit cards offering enticing rewards, cashbacks, and credit limits, many consumers are drawn to them without fully comprehending the potential downsides. One common oversight is what happens when a credit card remains unused for an extended period. This essay delves into the intricate details of how unused credit cards affect your credit score, the consequences of closing them, and when it might be advisable to do so.
1) Understanding Inactive Credit Cards
Credit cards are considered inactive when they remain unused for a substantial duration. The specific period defining inactivity can vary from one credit card company to another. Some issuers may categorize a card as inactive after six months of non-use, while others might extend this timeframe to one year. It’s essential for credit cardholders to be aware of their issuer’s policies regarding inactive cards to avoid potential consequences.
1.1 New Credit Cards and RBI Regulations
When it comes to new credit cards, there are specific guidelines outlined by regulatory authorities, such as the Reserve Bank of India (RBI), regarding their handling in case of non-use. If a cardholder fails to activate a newly issued credit card within 30 days of approval, they may receive an option for credit card activation via a one-time password (OTP). However, if the card remains unactivated for seven days beyond this point, the credit card may be canceled.
2) The Pitfalls of Closing Unused Credit Cards
One common misconception among credit cardholders is that closing unused cards is a prudent financial move. However, this decision can have a significant impact on your credit score and financial history. Let’s explore the reasons why keeping unused credit cards active is generally advisable.
2.1 Credit Utilization Ratio
One of the primary factors affected by closing a credit card is the credit utilization ratio. This ratio is a crucial component in determining your credit score and is calculated by dividing the credit card balance by the total credit limit, then multiplying by 100. A higher credit utilization ratio can adversely affect your credit score, making it harder to secure favorable terms on loans or other lines of credit. Therefore, closing a credit card, especially one with a substantial credit limit and a low balance, can inadvertently raise your credit utilization ratio.
2.2 Average Age of Accounts
Another critical aspect impacted by closing a credit card is the average age of accounts on your credit report. This factor is an essential element in assessing your creditworthiness. When you close a credit card, you reduce the overall average age of your accounts, which can negatively affect your credit score. Lenders often prefer to see a longer credit history, as it provides a more comprehensive view of your financial responsibility. Closing an older credit card can diminish the positive impact of your credit history on your score.
3) Determining When to Close a Credit Card
While it’s clear that keeping unused credit cards active can be beneficial for your credit score, there are situations where closing a credit card might be a reasonable decision.
3.1 Assessing Card Benefits
Before deciding to close a credit card, it’s crucial to evaluate the card’s benefits or lack thereof. If a credit card no longer offers valuable rewards, cashbacks, or benefits, and its annual fees and other charges are excessive, it may be sensible to consider closing it. However, even in such cases, alternatives like downgrading the card to a no-fee version might be worth exploring to preserve the card’s positive impact on your credit history.
3.2 Personal Preferences
There are instances where personal preferences or lifestyle changes may influence the decision to close a credit card. For example, if you have joint accounts with someone but wish to maintain financial independence or for personal reasons, closing a credit card might be a practical choice. However, before taking this step, it’s advisable to consult with financial advisors or credit experts to assess the potential credit score implications.
In conclusion, understanding the impact of unused credit cards on your credit score is essential for responsible financial management. While it may seem tempting to close unused credit cards to simplify your financial life, doing so can have adverse effects on your credit utilization ratio and the average age of your accounts, both of which are crucial factors influencing your credit score.
To maintain a healthy credit profile, it is generally advisable to keep unused credit cards active and use them for small expenses periodically. However, there may be circumstances where closing a credit card is a prudent choice, such as when the card no longer offers valuable benefits or when personal preferences dictate such a decision. In all cases, it is essential to make informed choices that align with your financial goals and credit management strategy.