Opening New Accounts May Impact Your Credit Score

Are you thinking about getting a new travel rewards credit card or applying for a new car loan?

It’s important to remember that applying for a new account doesn’t happen in a vacuum — it may affect your entire credit profile. There may be short-term and long-term credit impacts, depending on your situation. Here are some advantages and disadvantages to consider before pulling the trigger.

How a New Account May Hurt Your Score

Completing a credit card application can temporarily ding your credit in the short term, but how you use that new credit can have a much greater impact on your long-term credit score. Here are a few ways applying for new credit can hurt your score.

Hard Inquiry. When you open a new credit account, the creditor may pull your credit report to see how well you’ve paid your bills in the past. This is known as a hard inquiry. When a hard inquiry is completed, your credit score may take a hit. If it does hurt your credit score, it’s typically only a small ding. But if you apply for many cards or loans in a short period, the negative impact may be more severe.

Balance Increase. Just having a new credit account doesn’t necessarily hurt your credit. Once you begin making purchases and using the new credit available is when it affects your credit, more specifically, your credit utilization. Most experts recommend keeping credit utilization at 30% or lower, or only using 30% of your total available credit.

• For example, if you have a $5,000 credit limit and you spend $2,700 on a new home theatre system, your credit utilization rate is 54% (2700/5000 = 54%) for that credit card, which hurts your score. It also impacts the total credit utilization of all your cards and loans. Something to keep in mind when weighing your options for new credit.

Change to Credit Account Mix. Another component of credit score is the mix of revolving and installment accounts. Opening a new credit card (revolving) may hurt your credit score if you already have several open revolving credit accounts and lack installment accounts. For a good credit score, credit reporting agencies recommend having a mix of both revolving and installment credit accounts.

Lower Credit History. A good credit score shows a long and established history of using credit and paying back creditors on time. Adding a new credit account with no credit history skews the average age of credit when factored into the overall age of credit. Here’s an example to illustrate.

Note: Credit accounts are calculated in months.

• 4 accounts; 96 months + 60 months + 36 months + 24 months = 216 months/4 accounts = 54 months average age of credit

• 5 accounts; 96 months + 60 months + 36 months + 24 months + 0 months = 216 months/5 accounts = 43.2 months average age of credit

Just adding 1 new account lowers the average age of credit, and while it’s a minor factor in your overall score, it’s something to consider when shopping for new credit accounts.

How a New Account May Help Your Score

The longer-term implications of new credit accounts depend on how you use them. Here are a few ways a new credit account or credit card can improve your score.

Lower Credit Utilization. Opening a new card increases your total credit limit. As long as you don’t immediately rack up charges and your spending remains constant, your total credit utilization drops. And lower credit utilization helps your score.

Here’s a quick example. Let’s say you have 1 credit card with a credit limit of $2,000 and you’ve used $1,000, or 50% utilization. What happens when you add a new card and don’t increase spending? Your credit utilization goes down automatically!

• Card 1: 50% utilization and Card 2: 0% utilization.
• Total Credit Utilization: 50% + 0% = 50%/2 cards = 25% credit utilization just by opening a new card.

Increased Payment History. Paying on time, every month helps build good credit. Payment history accounts for 40% of your VantageScore.* Opening a new credit card or credit account gives you more opportunities to build up a solid payment history.

When to Open New Credit Accounts

The best time to open a new credit account depends on your financial situation. Applying for several loans at one time can ding your credit. Credit experts recommend waiting at least six months between credit applications.

Personal Impact of New Credit

Credit is widely available and easily accessible. You get new credit card applications in your inbox and mailbox almost daily. Although there are many offers out there, they may not all be in your best interest. There is much more to think about when opening a new account. The type of account, the frequency of new applications, and your current mix of credit accounts all play a part in your financial picture. Hopefully, you now have a better understanding of how to make the best credit decisions for your situation.

*based on VantageScore 3.0