Credit score: Canceling your old credit card? Here's how it can lead to higher loan interest rates in long run

Canceling an old credit card can potentially lead to higher loan interest rates in the long run due to its impact on your credit score. When you cancel an old credit card, your available credit decreases and your credit utilization ratio may increase, which can negatively affect your credit score.

Credit score is an indicator of your creditworthiness.

In the world of credit, old is often gold. Even if it's unused and collecting dust, that long-standing credit card in your wallet plays a significant role in your credit score, which can, in turn, impact your borrowing costs. It might come as a surprise to many, but cancelling an old credit card could potentially increase your loan interest rates in the long term. How? Let's delve into the fine print of credit score and loans to understand this seemingly surprising scenario.

Your credit score, a three-digit number, is an indicator of your creditworthiness. When it comes to credit scores, higher is always better. A high credit score indicates that you have a good track record of managing your credit and are likely to repay borrowed money on time. Generally, most of the lenders prefer a credit score above 800.

On the other hand, a lower score suggests that you pose a higher risk to lenders, and as such, they may charge higher interest rates to mitigate this risk.

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Now, let's consider what happens when you cancel an old credit card. Your available credit—the total credit limit on all your credit cards—goes down. But, your balances might stay the same, pushing up your credit utilisation ratio, which is the percentage of your available credit limit that you have already used. Credit utilisation is a crucial factor in your credit score calculation, and a high ratio could lower your score.

Here's where the potential for higher loan interest rates comes into play. Since lenders generally offer better loan terms to borrowers with high credit scores, having a lower score due to a higher credit utilisation ratio could lead to less favourable terms, including higher interest rates.

Fortunately, even if you've cancelled an old credit card, there are steps you can take to improve your credit score.

1. Maintain a low credit utilisation ratio:

Your credit utilisation ratio is the proportion of your total available credit that you're currently using, and it significantly impacts your credit score. To maintain a low ratio, avoid maxing out your credit cards and try to keep your usage below 30 per cent of your total credit limit.

2. Pay your bills on time:

Your payment history plays a significant role in your credit score. Ensure you pay all your bills on time, as even a single missed or late payment can negatively affect your score.

3. Diversify your credit mix:

Having a mix of different types of credit, such as credit cards, auto loans, and mortgage, can improve your score. It shows lenders that you can manage various types of credit responsibly.

4. Limit new credit applications:

Each time you apply for a new line of credit, a hard inquiry is made, which can slightly decrease your credit score. Limiting new credit applications can help maintain your score and show lenders that you're not urgently seeking credit.

5. Regularly review your credit reports:

Keep an eye on your credit reports to identify any errors or discrepancies. If you find any inaccuracies, dispute them with the credit bureaus. Correcting such errors can improve your credit score.

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