Does Canceling An Old Credit Card Hurt Your Credit?

A reader recently e-mailed me with a question about credit cards and his FICO credit score. Here's his question:

I have a question relating to annual credit card fees. One of my credit cards that i got about 7 years ago with HSBC has an annual fee of $37.00. I have developed positive credit history with it and it has a $1,400.00 limit and no rewards. I have since managed to get other credit cards with no annual fees and higher limits. My dilemma is whether i should close it down and take a hit on my credit score or keep it and continue to be charged the annual fee.

I confess that this question stumped me for a while. But a recent article by George Mannes, a senior editor at Money Magazine, helped answer this reader's question. The short answer is that canceling the card may lower your credit score a bit, but in most cases won't have a big impact. Of course, the devil is in the details, so let's dig a little deeper.
Your FICO credit score is composed of five factors: (1) your payment history, (2) amounts you owe, (3) length of credit history, (4) new credit, and (5) types of credit you’ve used. The three factors at issue here are your payment history, which makes up 35 percent of your score; length of credit history, which makes up 15 percent of your score; and amounts you owe, which accounts for 30 percent of your credit score.
How does closing your credit card affect these factors? Probably less than you think. The big negative impact on your score results from the percentage of available credit you lose by closing the account. If the card represented a significant percentage of your available credit, closing the account will hurt this aspect of your credit score.
But on the positive side, your good history with the credit card with not disappear, at least not right away. Most information, both good and bad, remains on your credit report for at least seven years. In fact, according to the article referenced above, the good stuff in your report stays put for 10 years. The bad stuff falls off the radar after seven years. Chances are that by that point it won’t matter much anyway if you’ve already started building a strong credit history and FICO score.
Before closing the account, however, there are some practical considerations to review. First, it's worth a few minutes of your time to contact your credit card company to see if you are able to either have the annual fee waived or have your card converted to a no fee credit card offer. For example, when I found out that American Express launched the Premier Gold card with rewards much better than the Preferred Gold Card I'd been carrying, I called up Amex and asked to switch. They accommodated my request without any fuss. If you can get the annual fee waived, your available credit won't drop as it would if you closed the account.
Second, if you decide to close the account, consider the timing. If you plan to purchase or refinance a home soon, for example, you may want to wait until that transaction closes before closing the credit card account.
Third, it's worth considering how the loss of the available credit will affect the percentage of your available credit. For example, if you don’t carry balances on your credit cards, whether you have $12,000 in available credit with the card or say $10,000 without it, you’re still not using any of your available credit. However, if you carry a large balance, the loss of $2,000 of available credit could have a more significant effect on your credit report.