Preapproval's the Secret for Not Dinging Your Credit Score
Some people like to pretend that FICO doesn't exist. If you are incredibly wealthy (and have, for example, your own radio show and millions in the bank), than you can safely ignore your FICO. However, if you need to borrow money to buy a home or a car, than having a good FICO is helpful. And, fortunately, it is not hard to do. If you pay on time and don't max out your credit cards, than you will have a good score.
Contrary to many rumors, you do not need to carry a balance and pay interest on your debt to have a good credit score. You need to use your credit cards, but you can pay them in full every month. If someone tells you that you need to borrow money to have a good score, they don't understand how the calculations work.
How Your FICO Score Is Calculated
The three biggest components of the FICO score are on-time payments, utilization and the length of your credit history.
- Making payments on time is approximately 35 percent of your credit score, and even a single missed payment can have a massive impact. For example, being 30 days or more late one time could take over 100 points off your credit score.
- Utilization, which is about 30 percent of your score, is calculated by dividing your total statement balance by your available credit. For example, if you have $10,000 of available credit and a statement balance of $2,000, then you have a utilization of 20 percent. Utilization is a much-maligned part of the credit score. If you only have one credit card, and use it every month for your everyday spend, than you could end up being punished. And, if you open a bunch of credit cards without using them, then you can have a very low utilization and a better score. But utilization is actually a subtle way of calculating whether you have the discipline to avoid using all of your available credit. The banks give you temptation: utilization measures how easily you succumb to that temptation.
- And 15 percent of your credit score is calculated by looking at how long you have had credit history. This is the easiest component to get right. Every day that you are alive is a day that this part of your score improves.
Don't Worry About 'New Credit' Most of the Time
Unfortunately, we tend to obsess about the 10 percent of our credit score that is often labeled "new credit." Every time you apply for credit, your score will decrease. The fact that you are looking for credit can send out a warning signal. And, if you apply for a lot of credit, that can become a very big warning signal.
However, a single application for new credit usually only takes 10 to 20 points off your score. And, so long as you don't max out your new credit card and build up your debt, the impact on your credit score is minimal and will be reversed over time. There are really only two times when you don't want to lose 10 points: if you are applying for a mortgage or auto loan in the next six to nine months. Otherwise, the worry about applying for credit is overdone.
However, I know that people will still be afraid of applying for new credit, because they fear the impact that it will have on their credit score. And, although one new application for credit is not a big deal, many people fear the impact that multiple applications have on their score. If they have to apply five times before they are approved, that will have a big impact.
Preapproved or Prequalified?
So, to reduce your chance of being rejected, you can visit a bank's website and see if you are preapproved for an offer. Checking to see if you are preapproved has no impact on your credit score. You can then check several banks and only apply once you know your are on the list. At MagnifyMoney, we have compiled a list of where you can check for preapproved or prequalified credit card offers.
If you are not on the list, that doesn't mean that you will not be approved. But this is a nice way to see where you can get credit without worrying about the impact on your credit score.
However, there is one final warning. Just because you are prequalified, does not mean that you will be pre-approved. When you decide to apply for a credit card, a bank will do a full hard inquiry. If your situation has changed since the bank last looked at your credit report, then you could be rejected. In addition, you will be providing information on your application that includes your employment status and income. If you are unemployed, of if your income does not look sufficient to service your debt load, the bank can still reject you.
However, if you want to see where you have a good chance of being approved, these prequalification lists can be helpful.
Nick Clements is the co-founder of MagnifyMoney.com, a price comparison website that helps you find the best deals in banking. He spent nearly 15 years in consumer banking, and most recently he ran the largest credit card business in the U.K.