How new credit impacts your score
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As my regular readers may know, there are five FICO factors that make up a credit score. These are payment history at 35 percent, credit utilization at 30 percent, credit history at 15 percent, credit mix at 10 percent and new credit at 10 percent.
Let’s look a little closer at that last item, new credit, and examine what it means for your credit score. Just as a reminder, VantageScore also considers inquiries under the “new accounts” category and counts them as “less influential” in determining your score.
This category includes the number of recently opened credit accounts and all new credit inquiries. The inquiries are those made by lenders before approving your request and will remain on your credit report for two years. They have very little effect on credit scores, and what little impact there is typically goes away after a few months.
If there is a new account, that will be the main thing lenders are interested in. If there isn’t a new account in a month or two following the inquiry, the impact of the inquiry goes away as it doesn’t represent any risk to the lender because there is no new debt associated with it.
What is new credit?
New credit is exactly what it sounds like—credit lines or loans that you applied for that you did not have before. Let’s take a minute and talk about what new credit is not.
Say you have a credit card with a $5,000 limit. You spend $2,500, leaving you with $2,500 of spending capacity available. If you access some or all of the remaining $2,500, you are not using new credit. Your lender has already approved you for your limit and it doesn’t matter how much or how little of it you use in this category. (Of course, accessing the credit as noted here would have a serious negative effect on the credit utilization portion of your score.)
Now let’s say you get an offer from a lender for a new credit card, loan or line of credit. These preapproved offers of credit are also not new credit (unless you take them up on the offer). These offers are just that—a pre-offer only. You still must formally apply and be approved for the credit that is being marketed.
If your application doesn’t hold up, you may find that you in fact do not qualify. Or you may find that you qualify, but not for as high a credit line or as low an interest rate as advertised. These offers always include language that says that the offer you received is not guaranteed and will be based on information in your credit report.
Now if you decide to apply, you have crossed into new credit territory with regard to your credit reports and score. The “new credit” category is triggered any time you apply for credit that you did not have before. This includes credit cards, of course, but also things like auto loans and mortgages.
These latter categories are ones that you may want to rate shop for. The credit bureaus and scoring mavens understand the importance of shopping around for the best rates and count multiple inquiries as a single one if they are made within a certain period of time. Depending on the score version your lender is using, that period may be from 15 to 45 days.
How do new credit accounts affect your score?
Once you have applied, you may see an increase or even a decrease in score. A lot of this depends on when the items are reported. Once an application is made it will be reported, but the timing between application and acceptance may lag and cause your score to temporarily dip due to the hard inquiry.
Although hard inquiries don’t have a very large impact on the average credit report, they can have a more serious negative impact on a credit file with a short credit history or few entries. These files are also called thin files. They may not cause a greater score decrease in terms of points, but when you already have a limited history and a low score, a few points could affect a lender’s decision more than it would for a person with a high score and extensive history.
But new accounts can also improve your score in a couple of ways. If you open a new credit card line but don’t access the credit, over time this will improve your utilization and overall score. Depending on the amount of credit, you could also access a small portion of it and see your utilization increase because your credit lines are now higher.
Finally, if the new account is for a category of credit you didn’t previously have (like a car loan or other installment-type loan), you will help your credit mix, which accounts for 15 percent of your score. This is an often-overlooked strategy for improving a credit score, and is especially helpful for those with “thin” credit files.
How do new credit inquiries affect your score?
Inquiries are simply a record that someone with a permissible purpose under the law has asked for your credit report. They may be credit grantors, employers, insurance companies and lenders, as well as yourself. But there are two types of inquiries—hard and soft. Only a hard inquiry counts here.
Hard inquiries are the result of your application for credit or other services. They indicate you may have additional debt that doesn’t yet show as an account in your credit report, so it represents a bit of risk to lenders. For that reason, they are shared with lenders and can have a small impact on your credit scores until the new account is added. You may see these listed in your report as “Inquiries shared with others.” As noted above, only hard inquiries will have an effect on your credit score. This also means that those preapproved offers need not concern you, as these are what are known as “soft” inquiries.
Soft inquiries are shown only to you (not anyone else, like a lender) on your credit report, and they don’t affect credit scores or lending decisions. They include things like preapproved credit offers, your requests for your own credit report, requests by employers or landlords to whom you’ve given your permission and insurance companies requesting your report. You may see them listed under a heading of “Inquiries shown only to you.” None of these inquiries will have any impact whatsoever on this portion of your credit score.
When should you apply for new credit?
In a nutshell: only when you truly need new credit. You should always approach any new credit with care and have a plan in place for repaying your debt. It is always a good idea to be fairly sure that you will qualify for any new credit before applying. It’s helpful to check your credit reports regularly; you can do this for free at AnnualCreditReport.com.
Normally available only once a year, during the current pandemic you can access your reports weekly at this site for free through April 2021. You may also have access to scores and reports through one of your creditors. I recommend using those resources before making the decision to apply for any new credit.
Have a credit score question for Steve? Drop him a line at the Ask Bankrate Experts page.