It’s in the back of everyone’s mind. Does applying for a credit card hurt your credit score? This question is extremely important to answer because a great rewards credit card is a luxury compared to a car or house. If you think a credit card application is going to mess up your credit score, you probably won’t risk it.
We’re going to walk through how your credit score is determined and what affects it. Armed with that information, you can make the best decision for you.
What is a FICO Score?
Creditors want to know if you’ll pay on time before they lend you money. Credit scores are a way to do that. A FICO score is one particular type of credit score. It’s a method developed by Fair Isaac Corporation. It’s also the most popular type of credit score. Credit agencies like Experian, Equifax, and TransUnion use the system developed by Fair Isaac to give you a FICO score based on the information they have about your credit history.
What Determines My FICO Score?
There are five primary categories that determine your FICO score. They are Payment History (35%), Amounts Owed (30%), Length of History (15%), Types of Credit (10%), and New Credit (10%). We’ll walk through each of these and give an explanation of how each affects you.
Payment History (35%)
Your payment history is the single most important factor in your FICO score. It goes without saying that the most important thing you can do for your credit score is pay on time. But, this is a huge reason to check your credit score regularly as well. I’ve had three or four situations over the years where a credit agency was listing a default or delinquency on my credit report that wasn’t mine. Checking your credit score for errors, and contesting them when they happen, can help keep your credit score up.
Amounts Owed (30%)
Remember, creditors are trying to assess risk. If you’re maxing out credit cards, it sends a red flag that you’re in financial turmoil. As a result, having more credit cards can actually help you. For example, if you have one credit card with a $5,000 limit and you owe $4,000, you’re using 80% of your available credit. That could signal a problem to a creditor. But, if you have four credit cards with a $5,000 limit ($20,000 total) and you owe $4,000, you’re only using 20% of your available credit. You owe the same amount of money either way, but you appear more stable in the second scenario. This is referred to as your credit utilization ratio.
How much you owe on installment loans is another factor. When you’ve paid down a large installment loan, like a mortgage, this signals your credit worthiness to lenders.
Length of Credit History (15%)
The longer you can prove you’re a reliable borrower, the more likely lenders are to trust you. But, it’s more than just your overall credit history. Lenders like to see longstanding open accounts as well. This signals dependency. It’s a reason to keep that old credit card you don’t use anymore. Canceling old credit cards won’t cause you problems per se, but keeping them open can be to your advantage. This is especially something to consider if the card does not have an annual fee.
Types of Credit (10%)
A diversity of loan types on your credit report will improve your credit score. If you can show you’re successfully repaying a mortgage, a car loan, credit cards, etc., it shows you’re a reliable borrower. If you only have credit cards or you only have a mortgage, the bank is less certain about how you’ll handle a different type of loan.
New Credit (10%)
This is the category that most directly relates to our question, “Does applying for a credit card hurt your credit score?” First, credit inquiries are taken into account on your FICO score for one year. They stay on your report for two years, but they only factor into your score for one year.
Second, occasional inquiries mean very little to lenders. But, a lot of inquiries in a short period of time can signal that you’re desperate for cash. Lenders use credit reports to determine risk. If you have a flurry of credit inquiries in a short period of time, they may likely assume something dramatic has happened in your life.
Conservatively, you should consider spacing out your credit card applications by six months. This would ensure you’d only have two on your credit report at a time that could affect your score. Also, it’s prudent to put off a new credit card if you plan to buy a house or car in the next few months.
Does applying for a credit card hurt your credit score?
Credit inquiries make up the smallest factor in your FICO score, fitting into the category of new credit (10%). The occasional credit inquiry, 2-3 times a year, will have little or no impact on your score. However, you would be wise to avoid a situation where your credit is pulled a number of times in quick succession.
Further, strategically adding credit cards can actually improve your credit score because it can help decrease your credit utilization ratio and build credit history.