A line of credit isn’t your typical personal loan that closes when you pay back what you owe.
It’s a revolving financial product that stays open after you make your payments.
As long as you keep it in good standing, your line of credit can stay open indefinitely until you or the lender closes the account.
If you haven’t used your line of credit in a long time, you might wonder if it’s worth keeping open.
Cancelling your account removes this extra responsibility from your plate, but it also wipes out all the perks that may come with owning this account.
Before you make a decision, keep reading. Below you’ll find out what you stand to gain (and lose) from closing this account.
You’ll Lose A Safety Net In Emergencies
Your line of credit plays a supportive role in your finances, beefing up your budget when your savings fall short of unexpected expenses.
This can come in handy in an emergency, since unexpected expenses can crash land in your life without any warning.
An open line of credit gives you the chance to respond promptly, even when an auto repair or medical expense blindsides you.
Cancelling this account removes this safety net. Once it’s closed, there’s no way to access these funds again.
Closing This Account Can Slow Down Your Response To Future Emergencies
The online loan experts at MoneyKey describe a line of credit as some extra cash on standby that you can access on a recurring basis.
Keeping it open means you sidestep the typical red tape involved with borrowing.
You won’t have to fill out an application, wait for a financial institution like MoneyKey to review your profile, or wait to access your funds once approved.
You can draw against your limit any time there’s credit available without having to go through this lengthy process.
While a financial institution such as MoneyKey expedites the borrowing process to ensure you get your funds as quickly as possible, nothing is fast as accessing an existing line of credit.
Your response time will be slower the next time you need help with an unexpected expense.
You Might Not Qualify For A New Personal Loan
Say you opened your old line of credit ten years ago when you had amazing credit. Now on the other side of a global pandemic, your score might not look too good right now.
Losing out on a loan over credit happens to plenty of people. In 2019, more than half of Americans (53%) were turned down for a financial product because their score was too low.
A low score may also cost you money. Lenders that apply risk-based pricing raise their rates on subprime borrowers to offset the risk they believe you represent.
Closing This Account May Affect Your Credit Score
Revolving accounts like a credit card and line of credit contribute towards your credit utilization ratio, a major factor of your score.
Your utilization ratio is the difference between how much credit you use to what you have available.
To find out your ratio, add up all the outstanding balances of your revolving accounts. Next, add up all the total limits of these accounts.
You’ll want to divide the sum of your balance by the sum of your limits, then multiply it by 100.
Let’s say you have two accounts worth $1,000, and you only owe $500 on one. You would divide $500 by $2,000 to arrive at a ratio of 25%.
Generally speaking, 25% isn’t that bad. Financial advisors recommend keeping your ratio below 30% at all times, although 1%–10% is the sweet spot.
Now let’s say you close the empty account. This would mean you would divide $500 by $1,000. This creates a utilization ratio of 50% — much higher than the recommended limit.
A too-high ratio may lower your score in the long run. However, the exact number it drops will depend on what already exists in your file, as your score factors all your borrowing habits.
Are There Reasons To Close An Account?
With so many downsides to your finances, most financial advisors don’t recommend closing an old account, provided it’s in good standing.
However, they might change their tune for the following reasons:
It Encourages You To Overspend
Research out of MIT shows revolving accounts can push consumers into spending far more than they can afford.
Wracking up large balances can stretch your finances to their breaking point, and ultimately cause damage to your score by spiking your utilization ratio.
If you can’t resist the temptation to spend, removing this account from your reach might be worth more than what you lose.
It Comes With An Annual Fee
Some accounts come with an annual fee you must pay, even if you don’t make withdrawals against your limit. Cancelling this account and switching to a no-fee alternative may save you money.
It’s A Joint Account With An Ex
Relationships can sour when you go through an ugly separation or divorce. Some people run up huge balances out of spite, knowing their partner is equally on the hook for these charges.
Cancelling a joint account once held with a former partner protects your finances from their vindictive spending decisions — and their forgetful ones, too.
It’s also a good decision even if your relationship ends on friendly terms. Your split means you don’t need to share finances anymore, barring extenuating circumstances.
Bottom Line: It’s A Personal Decision
Closing an account removes your safety net and may harm your credit score, but there are reasons why you might still go ahead with cancelling it.
Ultimately, your finances are personal, so only you can decide whether closing an account is worth it. Weigh up the pros and cons before you make the final decision.