Canceling a credit card can have a negative effect on your credit score, even if it's a brand-new card that hasn't been used yet. That's because your credit score takes into account the balances on your credit cards as well as the relationship between those balances and your overall credit limit.
Do the Math
Credit scoring formulas take several factors into consideration, one of which is called credit utilization. In a nutshell, it represents the balance on your credit cards expressed as a percentage of the total limit on those cards. Say you've got three credit cards, one with a $1,000 credit limit, one with a $1,500 limit and one with a $2,000 limit. Your therefore have a combined $4,500 worth of credit. Now say you have a $900 balance on each of those cards, or a total of $2,700. Your amount of credit utilization is $2,700 divided by $4,500, or 60 percent. Two things can increase your utilization rate: an increase in your total credit balances and a decrease in the total amount of available credit.
Lower Is Better
In general, the lower your credit utilization the better it is for your credit score. Credit scoring formulas rate a high credit utilization percentage as a risk factor. It could suggest someone is experiencing financial problems or is spending money irresponsibly. That means raising your credit utilization ratio is likely to lower your credit score.
Canceling a Card
Once you cancel a credit card the credit limit on that card is longer considered in your utilization rate. That's the case even if you haven't used the card yet. Continuing with the previous example, if you had $2,700 in balances on cards with a combined $4,500 limit, your utilization rate is 60 percent. If you get a new card with a limit of $3,000, your available credit would rise to $7,500 and your utilization rate would drop to 36 percent. That could help your credit score. Cancel the new card, though, and your rate would shoot back up to where it was before. That could be reflected in your credit score as well and probably not in a good way.
To Close or Not to Close
Some younger people have relatively low scores not because they have a bad credit history, but because they have a short credit history. The shorter your history the less information there is on your credit report. That means there's a bigger potential effect on your credit score because of a higher utilization rate triggered by canceling a card. That said, if having a new card proves to be an irresistible temptation to run up more debt -- which increases your utilization rate -- then you may be better off without it. Keep in mind that everyone's credit profile is different and credit scoring models vary, so it's hard to say exactly how much your score will be affected by canceling a card.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.