What You Need to Know First About Taking on New Credit

Before you go, we thought you'd like these...
Before you go close icon
a young man in suit shopping online with a credit card via a tablet computer
NEW YORK -- Hardly a day goes by that you don't get offers for new credit in your mailbox. And while the offers can be attractive, with great perks, low introductory rates and free balance transfers, that doesn't mean that you should jump at every offer of a new credit card. You might not just be setting yourself up for increasing amounts of debt. You can also negatively impact your credit.

Credit and Your Budget

"One of the first things you need to think about is how this will impact your budget," says Gerri Detweiler, director of consumer education with Credit.com. Each new line of credit is a new monthly payment. "How much will that payment be and how long will it last?" While you might be able to afford an extra $350 for a car payment today, will you be able to afford it three years down the line?

Detweiler points out that some changes in your financial situation are foreseeable. For example, you might know that you're retiring in two years or that your kids are going off to college. Or you might have an adjustable rate home equity loan that is going to go into full repayment. That's the kind of thing you need to anticipate and think about before you open up any new lines of credit.

Detweiler says that you should always ask if it will take more than three years to pay back any outstanding debt. "Usually, you want to pay off your debts in three years and certainly no more than five," she says. If you can't pay back what you're borrowing in three to five years, you're probably taking on more debt than you can realistically handle. "I bought a new car last year," she says. "One of the things right in my mind is that my daughter is entering college in a few years. That's the kind of thing you need to think about when taking on new debt."

Credit and Your Credit Report

"Depending on the type of debt, new credit could help or it could hurt," says Detweiler. Credit card accounts and revolving lines of credit will have an impact on your debt usage ratio, the second biggest factor after payment history on your credit. So if you open up a new credit card account, your overall utilization ratio (the percentage of available credit that you're using) will go down, potentially giving you a bump in your credit score. On the other hand, if you open a new card and do a balance transfer of 80% of that available credit, you're probably going to take a hit.

You also want to look at how many lines of credit you have open at any time. "Too many open lines of credit can paint a consumer as someone who relies upon borrowed money just to get by," says Randy Padawer, a consumer education specialist with LexingtonLaw. "A boat load of credit cards can damage your FICO score, even if you pay them all off every month and never max them out."

Padawer says that there's no way of knowing precisely where that number is, but he says that most people will see a degradation in their credit score with five cards or more. "If you have ten or fifteen cards, you've probably damaged your credit," he says. It gets worse, because closing accounts can also damage your credit through a shortened credit history and a higher utilization ratio. The best thing to do is to combine cards that are offered through the same bank.

"Remember that credit cards are just licenses to borrow money," says Padawer.

He believes that people all too often confuse a new line of credit with more income. "People get a shiny new credit card with a $15,000 limit and spend it on things they've always wanted," he says. "It's a terrible mistake and it gets lots of people into a whole heap of financial trouble."
Read Full Story

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

People are Reading