Does Cancelling a Credit Card Affect Your Credit in Canada?

Credit cards are powerful tools but can easily damage your credit score if used irresponsibly. The decision to cancel a credit card can indeed have significant consequences on your credit score. These include a decrease in credit limit, an increase in the credit utilization ratio, and a potential shortening of your credit history. These factors negatively impact credit scores and can make it challenging to secure credit in the future.

In this article, we will delve into the negative consequences of cancelling a credit card and provide actionable strategies to minimize any adverse effects on your credit score. We will examine the importance of maintaining a low credit utilization ratio and explore alternative options to cancelling a credit card. 

By understanding the implications of credit card cancellation and implementing effective credit management practices, you can protect and maintain your creditworthiness. 

Brief Explanation of Credit Cards and Credit Scores

In Canada, credit cards are an essential part of the financial landscape. They offer convenience, flexibility, and rewards, making them a popular choice for consumers. Credit cards are a form of borrowing that allows you to make purchases without paying for them upfront. When you use a traditional credit card, you are borrowing money from the issuer, which you must pay back with interest if not paid on time. 

What are Credit Scores?

A credit score is a three-digit number representing an individual’s creditworthiness. Lenders use a Credit score to determine the likelihood of someone repaying their loans. Credit scores range from 300 to 900, with higher scores indicating better creditworthiness.

When it comes to your credit score calculation, the exact formula used by credit bureaus and lenders is a mystery. However, several factors may affect your credit score. These include how long you’ve had credit, the length of time each credit has been on your report, your credit card balances, payment history, outstanding debts, and recent credit applications. 

The average credit score in Canada is around 650. A good credit score in Canada is anything above 700. This indicates that an individual is responsible with credit and has a low risk of defaulting on loans. A credit score can vary depending on the type of credit, with different scores required for mortgages, car loans, and credit cards.

The Importance of Maintaining Good Credit

Maintaining a good credit score is essential for accessing credit and other financial services. A good credit score signals to lenders that you are a reliable borrower, making it easier to get approved for loans, mortgages, and credit cards. Lenders and creditors will typically look at an individual’s credit score when evaluating them for credit. A good score can distinguish between approval and rejection for various products, such as credit cards, car loans, mortgages and rental applications.

Alternatives to Traditional Credit Cards

Not maintaining a good credit score can create a cycle where obtaining a traditional credit card becomes challenging. In such situations, you can turn to secured or prepaid credit cards. A secured card impacts your score, while a prepaid card won’t.

A secured credit card requires a deposit. The deposited amount then becomes your credit limit. For example, if you deposit $1,000, this becomes your credit limit. Although you lend to yourself, using the card will impact your utilization ratio and credit score.

Another option is a prepaid credit card. These cards function similarly to a debit card, but can earn you rewards or cashback. However, a prepaid credit card will not impact your credit utilization since the limit is technically zero. It’s important to note that cancelling a prepaid credit card will not affect your credit score. However, cancelling a secured card will.

What Happens When You Cancel a Credit Card?

Credit Utilization Ratio Increases

Your credit utilization ratio is crucial in determining your credit score in Canada. It represents the proportion of credit you utilize in relation to the total credit available to you. It’s important to note that your credit utilization ratio includes more than just your credit cards. This calculation encompasses additional forms of bank margin, such as personal lines of credit, and home equity lines of credit. However, your credit utilization ratio is not impacted by installment loans like mortgage or auto loan payments.

To illustrate the concept of credit utilization, let’s consider a scenario. Imagine you possess two credit cards, each with a limit of $10,000, providing a combined total credit limit of $20,000. Suppose you currently carry a balance of $5,000 on one card. If you cancel the other card (the one on which your balance is zero), your total credit limit would drop to $10,000. Therefore, your credit utilization ratio would increase from 25% to 50%. This change occurs because you are utilizing more of your total credit limit.

When you cancel a credit card, you reduce your total credit available. This can, in turn, increase your credit utilization ratio. The result will negatively impact your credit score, as lenders see a higher credit utilization ratio as a sign of financial stress.

Credit Limit Decreases

When you cancel a credit card, you also reduce your total credit limit. This can have a negative impact on your credit score, as lenders may see a lower credit limit as a sign of lower creditworthiness. Additionally, if you have balances on other credit cards, cancelling a credit card can also reduce the amount of credit available to you. This in turn can increase your credit utilization ratio and negatively impact your credit score.

Lose Credit History

Cancelling a credit card negatively impacts your credit history, which is a crucial factor in determining your credit score. When you cancel a credit card, you lose the credit history associated with that card, resulting in a shorter credit history. This can harm your credit score as lenders may view a shorter credit history as a sign of lower creditworthiness.

Alternatives to Consider Before Closing Your Credit Card

Cancelling a credit card can have a negative impact on your credit score. However, there are alternatives to consider before closing your credit card. Generally, the best method is product switching to a card without an annual fee. However, there are a variety of alternatives explained below. 

Consider Switching to a No Annual Fee Credit Card

If you are considering closing your credit card because of its high annual fee, it might be worth switching to a credit card with no annual fee. This way, you can avoid paying the annual fee and keep the credit history associated with the card. Every major credit card provider in Canada has several credit cards that offer no annual fee.

Consider Negotiating With Your Credit Card Issuer

Negotiating with your credit card issuer is another alternative to consider before closing your credit card. You can call your credit card issuer and ask if they can waive the annual fee or offer you a lower interest rate. If you have been a loyal customer and have a good credit score, your credit card issuer might be willing to work with you.

Consider Keeping The Credit Card Open But Not Using It

If you are concerned about your credit utilization ratio, you can keep your credit card open but not use it. This way, you can avoid cancelling the card and losing the credit history associated with it. However, it is important to note that some credit card issuers might close your credit card if it has been inactive for a long time. Before deciding to close your credit card, it is crucial to consider these alternatives and their potential impact on your credit score. By carefully weighing your options, you can make an informed decision that will benefit your credit score and financial health in the long run.

How to Cancel Your Credit Card Safely

Cancelling a credit card can hurt your credit score. However, sometimes it is necessary to close a credit card account. If you decide to cancel your credit card, there are steps you can take to minimize the impact on your credit score. Here are some safe cancellation steps to follow:

1. Check if you have points and redeem them before you cancel

If your credit card account has any reward points or cash-back points, redeem them before cancelling the card. Otherwise, you may lose your points if you do not use them before the account is closed.

2. Pay off the existing balance ensuring the balance is zero

Before cancelling your credit card, ensure you have paid off the existing balance. If you have any unpaid balances, it can negatively impact your credit score. Therefore, make sure that your balance is zero before you cancel your credit card.

3. Look to keep your oldest account open

The length of your credit history affects your credit score. If you have an older credit card account, it is best to keep it open. Cancelling your oldest credit card account can negatively impact your credit score. Instead, consider keeping the account open even if you don’t use it frequently.

4. Call your credit card company to deactivate your account

When you are ready to cancel your credit card, call your credit card company to deactivate the account. You can usually find the phone number on the back of your credit card. During the call, the representative will ask security questions to verify your identity before they proceed with your request. Inform the representative that you want to close the account. They may try to retain you as a customer by offering some incentives. If you still wish to cancel your credit card, decline their offer.

5. Write down the date and time of your cancellation and any confirmation number

After you have cancelled your credit card, record the date and time of your cancellation and any confirmation number provided. It is vital to refer to this information in case there are problems or disputes during the cancellation request.

6. Monitor your credit report for any changes

After cancelling your credit card, keep an eye on your credit report to ensure that the card is closed. Also that there are no unauthorized charges or other errors. You can get a free copy of your credit report from each of the three major credit bureaus once a year. Checking your credit report can also help you spot any other issues that might affect your credit score.

Cancelling Credit Cards: Bottom Line

Credit cards offer convenience and rewards but can also negatively affect your credit if you don’t follow effective practices. When cancelling a credit card, know that it will reduce your credit limit, increase the credit utilization ratio, and shorten your credit history.

Before cancelling, consider alternatives such as switching to a no-fee card, negotiating with the credit card issuer, or keeping it open but not using it. It is important to make informed decisions by carefully considering these alternatives and their potential impact on your credit score. By understanding the implications, you can protect and maintain your creditworthiness in the long run. Implementing effective credit management practices is key to achieving this.