The Power of Plastic: How Opening a Credit Card Affects Your Credit Score
In an age when our every financial move seems to have long-term consequences, many of us have begun to really scrutinize the money choices we used to make without a second thought. After all, it can be tough to bounce back from a bad financial decision, so avoiding flubs in the first place is a good way to avoid major headaches in the future.
A common question that consumers find themselves grappling with is how opening a new credit card will affect their credit score. The credit card industry would have us believe that plastic will do wonders for our overall credit report, but at the same time we're constantly hearing from personal finance experts that cards can be dangerous to our financial health. The mixed messages can be maddening, and we're faced with them all the time.
The truth is, the effect that opening a new credit card will have on your credit score really depends on your personal credit profile and history. While the immediate impact of opening a new credit card will cause your score to drop by about five points for a short period of time, it can be difficult to determine whether obtaining a new card will have a positive or negative long-term impact on your credit score. Let's review some general guidance.
When a new credit card can help your score
Your credit history is extremely limited. Building a credit history from scratch is difficult, but you'll need to start somewhere, and opening a credit card is an easy way to get the ball rolling. If you use the card responsibly -- paying it off in full and on time every month -- then opening a card is a great way to get on the path to a long and healthy financial life.
You don't have any other credit cards on your credit report. Ten percent of your credit score is determined by the types of credit you currently have on your credit report; ideally, you would have a mix of installments and revolving credit, so if you don't have any other credit cards in use at the moment, opening one could serve to boost your score.
You don't have much available credit, and you don't put any purchases on the new card. A whopping 30% of your credit score is determined by how much you owe, and approaching the credit limits on your cards definitely hurts your score. If some of your credit cards are maxed out (or pretty close), it will probably help your credit score to open a new card and then not make any purchases with it. Doing so will decrease the overall amount you owe relative to how much credit is available to you.
When a new credit card can hurt your score
You've opened too many new credit accounts in a short period of time. Ten percent of your credit score is derived from recent credit inquiries, so if you've taken on too many new accounts in a short window of time (about 30 days), obtaining an additional new card will hurt your score.
You don't have much available credit, and you immediately charge the card up. Again, 30% of your credit score is determined by how much you owe, so piling on to your debt load by opening a new card that you immediately charge up will ding your score, especially if you already owe quite a bit. Tread carefully, especially with retail credit cards, as many people add huge charges to these cards very quickly.
Also keep in mind that your credit score takes a hit when you open a new account. When someone checks your credit, it dings your FICO score about five points. If you have good credit, this isn't a big deal -- five points is a drop in the bucket. But if you're right on the border of qualifying in the first place, you'll want to be careful not to apply again too quickly.
Our credit scores are incredibly important to our overall financial lives, so it's important to take measures to keep our digits up. Consider your personal credit situation before opening a new credit card, as doing so can have a major impact on this all-important number.
The article The Power of Plastic: How Opening a Credit Card Affects Your Credit Score originally appeared on Fool.com.
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