Sierra Baldwin: Your credit score can be something that makes things either very easy or very
difficult for you. That's why so many people try to study up on how their credit score
is calculated and how the money moves they make could affect their score.
I'm Sierra Baldwin and in this video from The Ascent’s Money Lab, we'll take a look
at exactly what happens, the important factors in your credit score when you apply for a
new credit card. Does opening a new credit card hurt your credit
score? If you've done some homework on credit scores, then you know one of the FICO score
factors is new credit, which accounts for 10% of your score. Another 15% comes from
length of credit history, including the age of your newest account. So together, opening
a new credit card would have a negative effect on factors that account for 25% of your FICO score.
Let's walk through the process of getting
a new credit card to illustrate how this all works. The first step a bank takes when you
apply for a new credit card is to make a hard credit inquiry, which means it takes a look
at your credit report. A hard inquiry will negatively affect the new credit factor of
your FICO score, but the impact will be small if only have one or two credit inquiries on
your report within the past 12 months. After all, it's okay to apply for a couple of credit
cards per year, but if you're applying for dozens of them, lenders may think you’re
irresponsible, desperate for credit or both. If the bank approves your credit card application,
you'll see the account show up the next time you check your credit report. This also negatively
impacts the new credit factor. FICO will ding your score based on how long it's been since
you opened a new account and how many new accounts you have.
Side note: FICO is unclear on what it considers a new account.
On top of all that, a new credit card will negatively impact the length of credit history
factor of your credit score. Your length of credit history considers the age of your oldest
account, the age of your newest account and the average age of all accounts. The older,
the better. Opening a new card will reduce the age of your lowest account and your average
account age, thereby lowering your credit score. But this misses the big picture.
Based on all that, you might think opening a new credit card is a bad idea. The important
thing to remember is that the two most important factors in your credit score are your payment
history and your credit utilization ratio or the percentage of your available credit
that you're currently using. Combined they account for 65% of your credit score.
And a new credit card could help improve your credit utilization, which accounts for 30%
of your FICO score. Applying for a new credit card shouldn't have any impact on your payment
history, because you should be making your payments on-time and in-full every month.
On the other hand, a new card could have a major positive impact on your credit utilization ratio.
This ratio is simply your total outstanding credit card debt divided by your total available credit.
The lower the ratio, the better. As an example, let's say you only have one
credit card with a limit of $10,000 and a balance of $2,000, your credit utilization
ratio is 20%. But if you apply for a new card and get approved for an additional $10,000
credit line, your credit utilization ratio will drop to 10%. In other words, assuming
your spending habits don't change, you'll cut your credit utilization in half
and that can more than offset the negative impact of a hard credit inquiry and a decline in your
length of credit history. The final factor in determining your credit
score is credit mix, which accounts for 10% of your score. If you already have a credit card,
applying for a new credit card shouldn't have an impact on this factor. If you don't
already have a credit card, then a new credit card account on your report will have a positive
impact on this factor, further offsetting the negative effects of opening a new account.
Good habits lead to good credit. It can be easy to nitpick and get lost in
all the details of how your credit score is calculated, but here's the important thing
to remember. FICO rewards responsible credit usage. Yes, applying for a new credit card
could temporarily ding your credit score, but in the long-run it should provide a boost
as long as you use your new credit responsibly. That means, making your payments on time and
staying well below your credit limits. As long as you're diligent in those two areas,
then getting a new credit card won't damage your credit score, in fact, it could even
improve your credit score. If you're thinking of opening a new credit card,
check out our list of the best credit cards on the market at fool.com/creditcards.
The link is in the video description. And if you have your own tips or questions on
getting a credit card or boosting your credit score, leave them in the comments below.
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Thanks for watching and we'll see you next time on The Ascent’s Money Lab.