In my previous articles, I talked about three most important factors of FICO score.
Length of Credit History
Those three are the most important factors, and they amount to 80% of the FICO formula. So the other two cannot be as important, right?
That's right, but with a couple of qualifications. Here are two remaining components:
Types of Credit Used-10%
Conventional wisdom tells us that you shouldn't apply for more credit than you can use. If you value simplicity and don't care about getting benefits (which to me means profiting) from credit cards, this conventional wisdom will work for you just fine.
However, when pundits tell you that you shouldn't bite more credit than you can swallow, it doesn't mean you are going to be penalized for it. Well, you will, but the penalties are very mild, and they won't ruin your credit.
When you apply for a new credit card, the lender sends an inquiry to credit bureaus that we in the biz (LOL) call hard pulls. Those inquiries will shave a few points off your credit score.
If 2x2 equaled 4 in the FICO world, I would happily tell you what precisely you should expect applying for a new credit card. Then you would be able to make a clear-cut calculation and predict that your score would go down by, say, 4 points. You would most probably be OK with that knowing these four points are nothing to worry about, and your score would recover from this hit in no time--well, 3-6 months to be exact.
Unfortunately, FICO doesn't work this way. 2x2 could equal 3 for you and 5 for your cousin, 1 for your neighbor, or 8 for your boss. Since everyone's credit situation is different, no one can say with absolute certainty what exactly is going to happen to your score when you apply for that new account.
What we can say with certainty, though, is that applying for a few credit cards a year is not going to hurt to hurt you all in itself. What could hurt you is an irresponsible use of credit. In many cases, however, opening new accounts can even be beneficial to your score.
Say what? How can a new account increase my score?
It can because there is a much more important component in your score, utilization rate. We talked about this component in one of my previous installment, but just to remind you: that's the factor you should really be wary of!
Ideally, your utilization rate is below 10% within every one of your accounts, as well as across all of your credit cards. Sometimes, however, life might be far from ideal, so that achieving and maintaining this ratio turns into wishful thinking. In a situation like that, a new credit line can become an anchor that helps to keep you afloat.
Let's say, you have combined $30,000 credit spread among several credit cards. Let's say you have accrued combined debt about $6,000 which is 20% of your credit. At this point, you are getting closer to a dangerous 30% UR mark, after which your creditors might begin watching you more closely. A higher utilization rate will really hurt you. You don't want that.
Now, if at this moment you apply for a couple of credit cards with reasonably high credit lines, (and redistribute your debt afterwards) that might reset the scale. Will they penalize you by taking off four, six, perhaps even 8-10 points for opening new accounts? Yes. But extending your credit lines might give you some extra points for reducing your utilization rate, so you can still find yourself ahead.
And of course a bunch of hard pulls when you shop for a mortgage or car loans counts as one inquiry, so you shouldn't be worried about that, at all.
To be concluded
This is a post by Andy Shuman, a credit and travel expert who blogs at www.Lazytravelers.net. He writes and blogs during and between trips that he enjoys free of charge mostly due to creative use of credit card offers. He believes that credit cards are much more than just a convenient way to pay for a purchase, and that the benefits of responsible credit habits can go far beyond getting the best rates for loans and mortgages.
Andy is the author of bestselling books from Lazy Traveler Handbook Series available on Amazon. When he's not traveling, he lives with his beautiful wife and daughter in Brooklyn, NY.
Questions? Suggestions? Keep them coming!
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