Whenever we discuss our Fresh Start program with potential (and existing) clients, one question that invariably comes up is, “How will this affect my credit score?” So, here is exactly what new lines of credit can do to your credit score.
Taking a slice out of your credit score
Before we get into that, though, let’s take a look at what exactly makes up your credit score. Check out this pie chart from myFICO.com:
Just so there’s no confusion, let’s lay all these out.
- Payment history.
As you can see, this makes up the majority of your credit score. It takes into account all of your payment history for every item in your credit history. It also factors in adverse items on your report, such as judgments, bankruptcies, collections, and late accounts – and how many there are on file. - Amounts owed.
The second biggest piece of the pie, this looks at how much you owe on each of your accounts, as well as the number of accounts with active balances on them. It also factors in the proportion of revolving credit lines used and the number of installment loans still owed. - Length of credit history.
This looks at the time between when you opened an account, by account type, and the time since it last saw any activity. - New credit.
The focus of this article, this is determined by the number and proportion of recently opened accounts to your existing ones. It also looks at the number of recent credit inquiries, and factors in the re-establishment of positive credit. - Types of credit used.
The number and type of accounts (revolving cards, installment loans, mortgages, etc.) on your credit report.
Whew. Now that we’ve looked at exactly what goes into determining your score, let’s break down how exactly new lines of credit can work for you.
Inquire within
We’ll start with the inquiries the creditors will make into your credit history. You’ve laid out your case for the big new loan or credit line you need, and the lender seemed like a good guy; all that’s left now is the inquisition.
Whenever you apply for a new line of credit, the potential lender will pull a copy of at least one of your 3 credit reports to check your “credit worthiness” so they can determine how much of a risk there would be in extending you that new line of credit.
This means whichever report was pulled will now list a new recent inquiry on your credit history (if all three reports are pulled, they’ll all reflect that too). And since these inquiries make up 10% of your overall credit score, they are something to watch out for. Most credit inquiries count for a small number of points, and only inquiries made for new lines of credit will affect your score. Still, those few points can add up if you shop around for new credit too much in a 12-month period. Keep the damage minimal by shopping selectively for loans and credit.
Congratulations, it’s a new account!
So you’ve been approved for a new line of credit, and now it’s yours to do with as you please. However, some people may be surprised if they pull next month’s copy of their credit report to see how the new account is reporting, only to find their score has dipped a couple of points. What the…?!
When new accounts are placed on your credit report, that “shiny new” feeling can actually dent your score. It’s kinda like when teenagers show up to a college party. Because the account is so young, and because the length of your credit history accounts for 15% of your overall score, having new accounts on your report resets the clock a little bit, and can pull your score down a couple of points.
There’s a positive side to this, though. With new credit accounts, come new credit limits. And these limits (the higher, the better) are great at raising your scores back up, especially if your debt isn’t particularly high.
So what have we learned?
Whenever you open a new credit account, your overall credit score is likely to take a hit by a couple of points. And no, closing the account won’t reverse the effects – the inquiry will still be on your report, and just because you close an account doesn’t mean it’ll vanish overnight. As those new accounts stay open though, assuming you treat them right and pay them on time, they’ll start to work in your favor as they age, like a fine wine.
