Have you ever wanted to apply for a new credit card, but wondered if you would be compromising your credit score by doing so? Have you wondered if the card’s benefits, like a sign-up bonus or cash back on your gas and grocery purchases, would outweigh any impact on your credit?
Good news: applying itself has relatively little effect on your score in most circumstances. Whether that new account hurts or harms your score depends, for the most part, on how and when you use the card.
How credit card applications affect your credit score
For many people simply applying for a single card, whether approved or not, has a minimal effect on their credit score. It typically lowers it by less than 5 points, according to myFICO, the consumer division of the biggest credit scoring company. If you have a short credit history or only a few accounts, applying for a new card could have a larger effect on your score. So could applying for more than six credit cards over a short period. The effect of applying for a new card can last for 12 months.
Credit scores are based on algorithms, formulas that computers follow using the information in your credit file to determine whether you are a high-risk borrower, a low-risk one, or somewhere in between. If you have suddenly tried to open several new credit card accounts, it might look like you are having cash flow problems.
New credit only affects 10 percent of your credit score, however — more important is how you use that new credit.
Amounts owed: Credit utilization ratios and your credit score
Suppose that you currently have $5,000 in total available credit from two credit cards and you typically charge and pay off in full $2,000 a month. Your overall credit utilization ratio is 40 percent.
Credit scoring formulas see people with lower credit utilization ratios as a lower risk and add points to their credit scores accordingly. In this case, opening a new credit card can help your score.
“A good rule of thumb is not to spend more than a third of your available credit, so with a card with a $9,000 limit, don’t spend more than $3,000,” said Lee Gimpel, co-creator of The Good Credit Game, a curriculum kit for financial educators who teach classes about credit reports, credit scores, and credit cards, in an interview. (Learn more: Setting debt goals)
Your credit score will not take a nosedive if your utilization increases to 31 percent, however, nor will it soar if your utilization drops to 29 percent, writes credit scoring expert Barry Paperno in an article for CreditCards.com. The algorithms are more nuanced than that.
Since credit utilization accounts for about 30 percent of your credit score, decreasing that ratio by opening a new card, which increases your overall credit limit, but keeping your spending habits the same, may boost your score.
Of course, just because you have available credit doesn’t mean you have to spend up to it. Indeed, some argue that keeping credit spending lower than 20 percent is advisable, particularly if you are trying to improve your overall credit score. myFICO says that consumers it considers “high achievers” have an average revolving credit ratio of less than 6 percent and owe less than $3,000 on revolving accounts such as credit card accounts.
Paying your bills on time is key
Adam Jusko, founder and CEO of Proud Money , a card comparison and news site, said in an interview that since paying your bills on time is the most important part of your credit score, adding a new credit line when you already have a good credit history will have little impact on your score.
“That said, you don’t want to go overboard. If you are opening a new credit card every week just to get a sign-up bonus, you will eventually be noticed,” Jusko said. “Not only will your credit score go down, but the big banks will begin to reject you based on your recent history, especially if you’ve opened a different card with that same bank in the recent past.” (Related: Creating a budget)
myFICO says that your credit payment history accounts for 35 percent of your credit score. One or two late payments are OK, but the overall picture should be that you pay your loans and credit card bills on time. If you do have any late payments, how late they were also matters; a payment that was 33 days late will typically hurt your score less than a payment that was 93 days late. Similarly, being late on a large payment could hurt your score more than being late on a small payment, and being late on a recent payment could hurt your score more than being late on a payment from a few years ago.
Length of credit history affects your credit score, too
The length of your credit history accounts for 15 percent of your credit score, according to myFICO. The age of your oldest account, the age of your newest account and the average age of all your accounts are all factored into this part of your score.
The longer your credit history, the better — in general. How much any component of your credit profile affects your score depends on your overall profile. If you have a long credit history with lots of late payments and your cards are all charged to the max, your score will probably be lower than the score of someone with a short credit history who has low credit utilization and who always pays their bills on time.
“Your credit score is helped by having older cards with more history versus newer cards,” Gimpel said. “In other words, you’ll generally benefit by having a card that’s five years old versus one that’s five weeks old. If you’re always signing up for new cards and then canceling them, the chances are that will hurt your score because you’re not holding on to cards and letting them accumulate more history.”
Credit mix: A minor detail
The different types of accounts that appear in your credit report affect 10 percent of your FICO score. If you have a mortgage, a student loan, an auto loan, and a credit card, you might be scored more favorably for credit mix than someone who only has credit cards. The credit bureaus think that someone who has demonstrated that they can responsibly handle various types of credit might be less risky to lend money to than someone who has only shown that they can manage one or two types of credit. (Related: Good debt and bad debt)
But since this factor is a small component of your overall score and since you do not want to apply for or take out any loans you do not need, you should not spend your energy trying to manage this part of your credit score.
Exceptions to the rule
While opening a new credit card account can often help your credit score if you use your new card responsibly, there are times when opening a new account can hurt you. One of those times is when you are trying to secure a mortgage.
Lenders give the best interest rates to the borrowers with the highest credit scores, all else being equal. Scores range from 300 to 850. In general, a score that is considered very good (740 to 799) or excellent (800 and up) will get you the best rates. If your score is good (670 to 739), you will probably still qualify for a loan, but you may pay a higher interest rate than someone with very good or excellent credit. If your score is fair (580 to 669) or poor (below 580), you may not qualify at all, or you may pay a significantly higher interest rate. The rate you get will depend on the lender and the other factors the lender cares about, such as your employment status, income, and debt-to-income ratio.
Casey Fleming, author of The Loan Guide: How to Get the Best Possible Mortgage and a mortgage advisor with C2 Financial Corporation in San Jose, California, said in an interview that obtaining any new credit lowers your credit score, and by how much depends on the quality and extent of your previous credit history, so there is no way to definitively say how far your score will drop when you apply for a credit card. If you have a high credit score, a small drop might not affect you. But if you have a weak credit history, opening a new card right before applying for a mortgage is probably a bad idea.
If you have already made the mistake of applying, you can mitigate the damage by not using your card until your loan closes.
“Using your new card and running up your balance impacts your debt-to-income ratio. If you make abundant money or have no other debt and are buying a home that is easily affordable, that may not matter,” Fleming said. “But if you have lots of other debt—think car loan and student loans—and are buying as much house as you can afford, it could put your debt ratios over the top and cause a decline when you might otherwise have been approved.”
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This article was originally published in October 2016. It has been updated.