Temptations for opening new credit cards are everywhere – local events, at the mall and in your mailbox. Before you sign on the dotted line on another credit card application, make sure you understand how opening a new line of credit will impact your financial situation. While there are some situations where a new card will boost your credit score, in most cases, opening a new card could hurt your credit score rather than help it.
When you open a new line of credit, this impacts your credit score in three ways: a new credit inquiry, an increased number of open accounts and your utilization ratio.
- The impact on your credit score as a result of a new credit inquire is relatively minor. Plus, within a few months, that change will likely disappear from your score completely.
- With a larger number of open accounts, you may find that one more new account could pull your score down slightly. This will become more and more of a problem if you already have numerous lines of credit.
- Your utilization ratio is the ratio of your credit card balances to credit limits as listed on your credit report. For example, if your balance is $400 and your credit limit is $1,000, then your credit utilization is 40 percent. You should try to use no more than 50 percent of your credit limit at any time, even if you pay the balance every month. The available credit on your new card may make that easier, provided it doesn’t tempt you to spend more and use it up.
With these factors in mind, we’ve put together a list of three scenarios when opening a new credit card will benefit you.
It’s your first card.
If you’ve never had a credit card in your name before, getting a new card will likely boost your credit score. Establishing a credit history is an important step in showing future lenders that you are capable of paying off debt.
A great way to build up a good credit record from scratch is by being a good credit card customer. Use your card and pay your bill on time each and every month, and slowly but surely you’ll establish a sound payment history.
You want to repair your credit score.
If you have damaged credit and you need a positive payment history to offset past delinquencies, opening a new card may be a good idea. However, be sure that you charge only what you can afford to pay on your new credit card and always make your monthly payments on time.
You want to lower your utilization ratio.
If you have a high credit utilization ratio that is 50 percent or higher, a new card will help you lower that percentage.
Let’s say you have one credit card with a $10,000 limit and you carry a debt of $5,000 on it. This results in a 50 percent utilization ratio, which will likely result in your credit score going down. If you open two more credit cards, each of which also have a $10,000 limit, you will end up with a total credit limit of $30,000 and debt that is still $5,000. Instead of a 50 percent utilization ratio, you now have a 16.6 percent utilization ratio, which is much better.
Note that this strategy will only work if opening two more lines of credit won’t tempt you to spend more.
You should always think twice before opening a new credit card. With careful consideration you can make an educated decision about your finances that will impact your financials for many years to come.