This comprehensive guide will answer all your burning questions about escaping the credit card trap.
1. Implications of Closing a Credit Card with Outstanding Debt
Closing a credit card while still owing on it has two major repercussions. First, your previously agreed upon minimum monthly payment is no longer valid. Instead, the entire debt becomes due immediately. However, it’s worth noting that the credit card company will not completely close an account if there’s a balance remaining. They might restrict the account’s use or lower the limit to zero, but the account will remain open until the balance is fully settled.
The second issue arises with your credit rating. Abruptly reducing your credit limit to zero could significantly affect your credit score. Your credit score is sensitive to your credit utilization ratio, which is the proportion of your available credit that you’re currently using. For example, if you have a $5,000 credit limit and you owe $3,500, your credit utilization ratio would be 70%—which is usually the maximum recommended ratio. However, if you cancel the card, your limit becomes zero and this dramatically impacts your credit score.
2. Effects of Closing a Zero-Balance Credit Card on Your Credit Score
The impact of closing a zero-balance credit card on your credit score isn’t straightforward. It depends on your individual circumstances. However, it is certain that this action will have an effect on your credit rating as all credit-related activities are reported to the two major credit bureau companies in Canada: Equifax and TransUnion.
The impact could be temporary or long-lasting. It’s hard to predict the exact change in your credit score as the credit scoring algorithms used by Equifax and TransUnion are proprietary and not publicly disclosed.
Debunking Credit Score Myths
Closing a credit card can also increase your credit utilization ratio as the overall credit available to you decreases. Moreover, if the cancelled credit card was your only form of revolving credit or your longest-standing credit account, it could lead to your credit file aging prematurely and essential information disappearing, leaving you with a deficient credit history.
3. Should You Cancel a Credit Card After Paying It Off?
The decision to cancel a credit card after paying it off is entirely up to you. Keeping one credit card open with zero balance is fine, provided you use it occasionally to keep it active. However, if you’re fearful of falling back into debt, you can keep the card in a secure place and only use it for pre-authorized monthly payments for a fixed amount. This can help maintain an active credit file and improve your credit rating over time.
However, if you have multiple credit cards, getting rid of the ones you no longer use can protect you from impulsive spending. Moreover, if you’re planning to apply for a loan or a mortgage in the near future, keeping only the credit cards you actively use can enhance your chances of approval.
4. Smart Use of Credit Cards
While the information about credit ratings and credit card cancellation may seem contradictory, it all boils down to wise credit usage and budgeting. Here are answers to two common queries:
Do Credit Card Companies Prefer Full Payments Every Month?
Yes, they do. Even if you don’t pay any interest, they still profit and appreciate a client who maintains their account in good standing.
Is Paying Off the Entire Balance Every Month the Only Way to Improve Your Credit Score?
No, several factors influence your credit score. Consistent, timely payments are crucial, and making only the minimum payment occasionally won’t harm your score. However, consistently paying only the minimum while continuing to use the card for purchases could gradually affect your score negatively.
5. Consumer Debt: Getting Help
Consumer debt is at an all-time high, and many individuals are concerned about managing their debts. If you feel trapped by credit card debt and wish to cancel your cards or eliminate your debts, there are ways to find relief. While you can’t just stop paying your credit cards, there are solutions for seemingly dire circumstances. Reach out to us for guidance and practical solutions to your financial concerns.
Remember, the key to escaping the credit card trap is not just about managing your current debt but also developing smart spending habits to prevent future debt. This comprehensive guide aims to help you navigate the complex world of credit cards and debt management—empowering you to break free from the credit card trap.
