Credit card companies try their hardest to offer the latest and greatest in rewards, cash back, and other incentives to get you to sign up. When you sign up for a new card, chances are it'll replace a credit card you're currently using. What are you supposed to do with this now-obsolete card? You could cancel it, but that can have a negative impact on your credit score, or you could just shelve it. Just put it in a safe place and stop using it. Some go as far as to freeze it in a block of ice so they aren't tempted to use it!
Years ago, before people started researching credit cards and credit scores, it wasn't common knowledge that canceling a credit card could hurt your credit score. Now that our understanding of the system has evolved, we know that it does. Will we, in a few more years of studying, realize that inactivity could be dangerous as well?
Inactivity Won't Directly Hurt You
As it turns out, we have been studying and it's pretty clear that credit card inactivity will not directly hurt your score. Fair Isaac Corporation, FICO, doesn't tell us its credit score formula but it does discuss the various factors that play a role in determining that three digit number. Payment history, amounts owed, length of credit history, new credit, and types of credit used are the five major categories they identify.
You might see "types of credit used" and think that inactivity could hurt you. In reality, if you are using any type of revolving credit, such as the new credit card, you're going to satisfy that factor of the score. If you stop using revolving credit entirely, your credit score might go down. This makes sense intuitively, because lenders can't be sure someone can be responsible with unsecured credit if they aren't using any unsecured credit at all. If you have two credit cards and only use one of them, they have enough information to make an educated determination.
Inactivity May Lead to Cancellation
There is a situation where your credit score can be hurt by inactivity. Credit card companies make money when you use their card to make purchases. Every time you swipe the card, they charge the merchant for the transaction. These interchange fees, plus the interest and fees the cards charge you, make up the bulk of the company's revenue. When you stop making purchases and don't carry a balance or pay an annual fee, you are not making the credit card company any money. In fact, because they have to maintain your account, you are costing them money. When this happens and the company believes you're gone for good, they may cancel your card.
If they cancel your card, it's as bad for your score, and for the very same reasons, as canceling it yourself. It may even be worse, since the account will be closed at the lender's request, rather than at the consumer's request. The best way to avoid this is by making a few purchases to avoid being labeled an inactive account. I've gone years without using my Discover card and it hasn't been closed, but a Citi card I stopped using for a year was recently cancelled.
While credit card inactivity isn't going to directly hurt your score, the issuer may opt to close the account because it's losing them money. If you don't intend to get any large loans, such as a mortgage or a car note, this isn't that big of a concern. If you are planning on buying a home or new car, put a few small purchases on your shelved credit cards to avoid a surprise closure.
Jim Wang writes about personal finance at Bargaineering.com. When he's not tackling money issues, he's usually looking forward to his next vacation and writing about it at Wanderlust Journey.
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