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How Card Applications Affect Your Credit Score

by on July 16, 2014 · 28 comments

in Credit Cards, Credit FAQ, TPG Contributors

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Today, TPG contributor Jason Steele reviews how new credit card applications impact your FICO score, and reminds us to consider the big financial picture when playing the points and miles game.

There’s no way around the fact that credit card sign-up bonuses are among the quickest and easiest ways to earn points and miles. Even if you received your airline tickets for free, it would still take you around 100 hours in the air to earn 50,000 miles, which is what many credit cards offer after spending 60 seconds completing an application, and then using the card to make everyday purchases.

Yet I find that new points and miles enthusiasts are often reluctant to dive headlong into a card application out of concern for how it might affect their credit. So today I want to answer one of the most common questions I get from folks who are new to the game: “How do new card applications affect my credit score?”

Short answer: Not much

Opening a new line of credit has both positive and negative affects on your score. On the positive side, being extended a new line of credit reduces your debt-to-credit ratio (for a given amount of debt). Remember, your credit history and your credit score consider your “debt” to be the sum of all of your most recent statement balances, regardless of whether you avoid interest by paying them in full. Therefore, having a larger total line of credit minimizes your debt-to-credit ratio and improves your credit score.

As an example, suppose you had one card with a credit line of $5,000, and you maintained a balance of $1,000. Your debt-to-credit ratio would be 20%. If you then opened a second card also with a line of $5,000, your debt would remain the same, but your total line would be $10,000, so your debt-to-credit ratio would fall to 10%. This makes you appear less risky in the eyes of credit bureaus, and increases your score accordingly.

Opening a new card also increases your total credit history (the number of data points available for creditors to gauge your credit-worthiness). In fact, people who try to improve their credit score by avoiding credit cards, or having just one open account, often find that their scores are not nearly as high as they expected.

Image courtesy of Shutterstock.

Image courtesy of Shutterstock.

On the downside, opening a new line of credit can reduce the average length of the accounts in your credit history. It also impacts the portion of your credit score called “new credit,” which penalizes you for opening up too many new lines of credit in a short period. FICO doesn’t do this to discourage people from earning travel rewards, it’s just that their credit scoring formula interprets such behavior as a sign of financial distress, like someone taking out several new loans to pay bills.

On the whole, the positive and negative consequences of opening a new credit account largely cancel each other out. Those who open up a single new credit card account typically find that their scores go up slightly, as the scoring formula doesn’t really penalize them for adding a single new line of credit. Those who open up multiple accounts in a short period of time typically see a modest, temporary drop in their credit scores (although most see overall improvement as time passes and the average length of credit history increases).

If having a credit card just enables you to make unnecessary purchases, reconsider your use of these products. Image courtesy of Shutterstock.

Image courtesy of Shutterstock.

This short-term drop is rarely significant enough to move an “excellent” credit score down to just “good,” but those who are about to apply for a new mortgage or other substantial loan would be wise to take a break from new credit applications until they complete the process. Besides, a mortgage application looks beyond your mere credit score and delves into the details of your credit report; applying for many credit cards will raise unneeded questions during that process.

Keeping perspective

I could go on all day about the nuances of debt-to-credit ratios and various theories on how to improve the average length of your credit accounts, but I don’t believe there’s much to be gained by diving too deep into that area. The exact FICO consumer credit scoring formula is a secret, but they disclose that your length of credit history only comprises 15% of your score, and the “new credit”  portion is a mere 10%.

FICO

The FICO scoring formula puts an emphasis on your payment history and amounts owed. Other factors are minor by comparison.

In contrast, your payment history makes up a whopping 35% of your credit score, and your amounts owed is another 30%, each of which is greater than the cumulative weight of your length of credit history and your “new credit.” The moral of the story, then, is to always pay your bills on-time and carry very little debt. If you do those two things, your credit score will likely be excellent (unless you go out of your way to avoid having any credit history at all).

The pitfalls of credit card use

There’s one crucial way that credit cards can upset your finances in general: interest. About two-thirds of American credit card users regularly carry a balance on at least one of their accounts, leading to costly interest charges. Many of these credit card users view opening a new line of credit as an invitation to spend more money and incur more debt.

Those who carry a balance that accrues interest on their credit cards should forget about earning travel rewards and instead focus on paying that debt off as soon as possible. Reward credit cards invariably have higher interest rates than non-reward cards, and offer less attractive promotional financing. Earning $25/month in airline miles won’t do you any good if you’re losing $25/month (or more) to interest by carrying a balance.

Furthermore, those who would be tempted to use a new line of credit to make unnecessary purchases, or who have trouble controlling spending, should question their use of credit cards altogether.

If having a credit card just enables you to make unnecessary purchases, reconsider your use of these products. Image courtesy of Shutterstock.

If credit cards just enable you to make unnecessary purchases, reconsider whether new applications are a smart move financially. (Image courtesy of Shutterstock)

Bottom line

Credit scores and credit cards are tools, and like many tools, you should learn to wield them correctly or someone will poke an eye out. Credit card applications won’t hurt your credit score in the long run, but make sure your applications and expenditures are sensible in the scope of your own personal finances. Spend responsibly, and pay your balances in full and on time, and both your credit score and your points and miles accounts will prosper.

For more information about credit card applications and FICO scores, check out these posts:

What Is the Best Credit Card for a First Time Applicant?

How to Get a Free FICO Credit Score from Certain Credit Cards

How Can I Save My Credit Score After a Late Payment?

Top 7 Ways for College Students to Build Credit and Rack Up Points and Miles

 

Disclaimer: The responses below are not provided or commissioned by the bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by the bank advertiser. It is not the bank advertiser's responsibility to ensure all posts and/or questions are answered.

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  • SC

    As someone who works in the credit card industry, I can tell you that some of this posting is reasonably accurate, some of it is entirely inaccurate. No one should read this post and draw any meaningful conclusions from it. The author is not an authority on the subject at all.

  • Jill

    Thanks for adding value by pointing out what may be inaccurate.

  • TR

    SC: I’m interested to hear what is entirely inaccurate. So far this article has lined up with my experience, but I could be missing something.

  • lindseywagners

    Please elaborate with some evidence, because right now I have no idea if you know what you’re talking about either, and I don’t know what to think.

  • RJ

    Yes, please substantiate your claims.

  • wayne

    My personal experience with playing the points game for the last 3 years is it has almost no effect on your fico credit score as outlined above in the article. The negative effect that I did experience had to do with my Insurance Credit Score, which rates the number of recent credit card inquires to a higher factor, resulting in my homeowners insurance going up 40%. Which is complete BS, I have a fico credit score of about 800, never had a delinquent account or anything negative posted to my credit.

  • dcsells

    Thanks for this post, which perfectly describes me–a points newbie ready to dive into credit-card bonuses but afraid of the impact on my (excellent) credit. I would be interested to hear from commenters who have played the points game for several years as to whether they found it to have any impact on their credit scores, particularly when a good credit score is most needed (e.g., mortgage or auto loan). The more data points of people who can attest that it has not been a problem, the better. Thanks.

  • StL

    My wife and I had good credit scores, good credit history, and a solid financial situation when we started following some of the guidelines from TPG and other bloggers. Over the past couple of years we’ve opened and closed more than two dozen credit card accounts of all types (with a couple of rejections along the way). In that time we’ve received about 2 million miles/points and seen our credit scores rise from about 750 to over 820.

  • SC

    While the company behind FICO and other websites put out handy references to what factors go into credit scores, the actual math/formula is much more complicated and can include factors such as debt-to-income ratio, total credit lines, inquiries in past 6 months, home ownership, revolving credit balance, length of employment, major derogatories, open credit lines, balance utilization, among others. A wide range of factors will determine/influence the impact on a FICO score. Depending on the individual and the interaction of these factors, opening a new account could have a significant or an insignificant impact on a FICO score, and the impact could be positive or negative. Separately, almost no issuers make credit decisions solely on FICO (in fact, most do not use FICO at all). Instead, they have complex algorithms that in some ways resemble FICO but in other ways could be materially different. Having said all this, I would guess that most people who read this blog are reasonably savvy and will figure out ways to manage credit accounts in ways that do not have materially negative impact on FICO or bank appetite to underwrite. That probably cannot be said for many/most Americans overall, however.

  • Ben

    Over the last two years, I’ve opened more than a dozen accounts and purchased a new home. My credit has dropped from the high range of excellent to the low range of excellent. I have not had any other adverse consequences (unless you count a lousy meal on Air Canada Business Class)

  • SC

    One additional point: while people are wise to aim to maintain strong FICO scores, FICO scores have very little impact on ability to get a mortgage or on a mortgage rate/terms. Mortgage lenders have all moved away from FICO and have their own algorithms and underwriting standards. Some of those algorithms and standards overlap with FICO, but most in fact do not. A person can have a high FICO and have difficultly getting a mortgage on attractive terms, and vice versa, for any of a number of reasons. The case is similar for other kinds of loans, including auto, small business, personal loans, etc.

  • jeff

    My experience is the same as Ben. I have gone from perfect to probably very good. (ie. I can get a loan if need be.) I have a long history of perfect credit though. I do not have millions of miles and I’m still conservative. I have never bought anything I didn’t already have money to pay for on my credit cards. Your credit score is yours. What are your needs? I have refinanced my home a few times. I can make a lot more money doing that and paying for a flight than flight rewards credit cards if I need to refi for example. Bloggers are doing this for money not because they are nice guys. I would probably not “DIVE IN” but take it slow.

  • Guest

    SC – stop trolling, or give specifics. I can say I’ve been playing the game 3 years (approx 30 inquiries over 3 years) and I still have an 800+ FICO.

  • jtgray

    SC – stop trolling, or give specifics. I can say I’ve been playing the game 3 years (approx 30 inquiries over 3 years) and I still have an 800+ FICO…

  • http://www.jasonsteele.com/ Jason Steele

    Jill: I agree with what you are saying here, and it appears consistent with what I wrote. My overall thesis is that people should spend less time trying to game FICO and overthink their credit scores. Pay your bills on time, carry little debt, and the rest will work out. FICO sees many new credit apps in a short time period as a possible sign of economic distress (rather than a pursuit of points), and it can have minor, temporary effects. Otherwise, opening up a new account has relatively little net effect, but is often positive.

  • SC

    While the company behind FICO and other websites put out handy references to what factors go into credit scores, the actual math/formula is much more complicated and can include factors such as debt-to-income ratio, total credit lines, inquiries in past 6 months, home ownership, revolving credit balance, length of employment, major derogatories, open credit lines, balance utilization, among others. A wide range of factors will determine/influence the impact on a FICO score. Depending on the individual and the interaction of these factors, opening a new account could have a significant or an insignificant impact on a FICO score, and the impact could be positive or negative. Separately, almost no issuers make credit decisions solely on FICO (in fact, most do not use FICO at all). Instead, they have complex algorithms that in some ways resemble FICO but in other ways could be materially different. Having said all this, I would guess that most people who read this blog are reasonably savvy and will figure out ways to manage credit accounts in ways that do not have materially negative impact on FICO or bank appetite to underwrite. That probably cannot be said for many/most Americans overall, however.

  • James

    How does a loan application for a house or to lease a vehicle impact your score?

  • http://www.jasonsteele.com/ Jason Steele

    FICO rewards different types of credit, so that can help. On the other hand, if your payments are high, relative to you income, that can hurt somewhat. So long as you keep your debt level low, compared to your income, you will build credit history and improve your score.

  • Martin

    Stop trolling this post. The information appears to be accurate.

  • Trav

    That’s interesting. I hadn’t thought about that. I called my insurance company (Farmer’s), and they said that they only pull this score for someone who is applying with them for new insurance. They don’t do it again for renewals, but each insurance company may be different.

  • dee seiffer

    My husband and I have been opening and closing accounts for pts & miles in earnest for about 3 1/2 years now. We refinanced our house during that time, also. Our credit scores were excellent to begin with and are now usually higher than when we started. Sometimes after a run of applications, our scores will come down temporarily below 800. But they go back up within the next couple of months.

  • sirdebo

    i think the title can be misunderstood. for me, i read this as applications which lead to inquiries on my credit, not the impact of a new account. i think the title should read “how new accounts affect your credit score” or, write an article on the impact on inquiries.

  • Kioly

    You can usually qualify for the lowest promotional auto loan rates with ~720-730 FICO (yes, I know they don’t use FICO directly, but it’s a reasonable benchmark. If your credit is in fact excellent, it would be quite hard to drop below this by responsible credit card churning- unless you massively increase utilization, start missing payments or pick up a derogatory.

  • Kioly

    (That’s for car loans. Mortgages rates are more fine-grained and so there is a significant difference between 850 and 730.)

  • JM

    Started out with excellent credit 1.5 years ago. Opened about 5 business accounts and about 10 personal accounts, closed more than half of them since. My credit is still excellent, though it did just recently drop a bit more. I’m assuming due to hard inquiries and closed accounts. No biggie – the score will rise again :D

  • mleblancjr

    Is your first sentence saying that a person’s FICO score uses the factor of debt-to-income? I don’t believe that’s true… CC, loans and other financial applications may use it as a factor, but does your FICO score?

  • Rene

    I would love to see a follow-up article addressing when and which credit cards it’s appropriate to close, without negatively impacting your credit score.

  • http://www.thepointsguy.com PR@TPG

    This post from last year answers those questions, but we’ll look at whether an updated post is warranted:

    http://thepointsguy.com/2013/03/when-to-cancel-a-credit-card-my-personal-card-inventory-and-decision-process/

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