A credit card is a potentially useful instrument. In that sense, it’s much like a loan repayment calculator or any other financial tool: if you employ it the right way, it can be beneficial to you. If you misuse it, it can be problematic.
For instance, with credit cards, it’s easy to overextend yourself. If that happens, you might accrue more debt than is easy for you to pay back. In those circumstances, you may think about canceling a credit card and closing out the account once you pay off the outstanding balance.
Is that the smartest play, though? In some cases, downgrading the card is possible. Let’s talk about whether downgrading a credit card or canceling it is the best move.
First, let’s go over what can happen when you cancel a credit card. If you cancel a card and close out your account, that will negatively impact your credit score. The reason is that your FICO or VantageScore are both partially dependent on your credit utilization ratio.
Your credit utilization ratio is measured by looking at how much credit you have available vs. how much you’re using. If you have quite a bit of credit available, but you’re using very little of it, that causes your score to rise. If you cancel a credit card, that means you will have less available credit, and your score will drop accordingly.
Canceling also negatively impacts your credit history. That’s because closing a credit card that you’ve had for quite some time lowers the average account age on a credit report. If you’re attempting to get a loan, you want a higher credit score, as reflected by keeping open longstanding accounts.
Now, let’s talk about downgrading a credit card. Downgrading isn’t an option with all cards. When you downgrade, that means you’re trading in your current card for a card from the same company that has fewer perks and possibly a lower credit limit. When considering this option, the first thing to do is to check availability.
Assuming you have a card that you can downgrade, doing so might still negatively impact your credit utilization ratio, causing your overall score to drop. That’s because if you downgrade a card, you’ll likely have less of a credit limit on it. If you have less possible credit to use, that could cause your score to take a hit, even if you didn’t completely close out the account.
However, if you downgrade an account, it won’t impact your credit history. You’ll still have the account open, which means your score will probably not drop nearly as much as if you canceled it entirely.
Which is Better?
Now, you see the different ways downgrading and canceling a credit card account can impact your credit score. With both cancellation and a downgrade, your credit score will probably take a hit.
Still, that hit will not be as bad with a downgrade as it would be with a cancellation. Your available credit to utilize will be less with both options, but if you downgrade, that won’t impact your credit history.
Because of this, it’s generally a better idea to downgrade an account rather than close one, assuming that’s an option.
Consider This Decision Carefully
Everyone’s financial situation is different, so we can’t say with certainty that downgrading always trumps cancellation. However, your credit score will probably take less of a hit if you downgrade vs. cancel for the reasons we mentioned. This means downgrading is often the better move.
You might make an exception and cancel a card, though, if you feel like the temptation to spend beyond your means is too great when you have one. If so, canceling may be the better choice, even if your credit score takes a larger hit.
Remember that you can rebuild your credit score regardless of what you choose. Just because it takes a hit because you downgraded or canceled a credit card account doesn’t mean it will remain that way permanently.