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Your FICO credit score is made up of five main components: payment history (35%), credit utilization (30%), credit history (15%), credit mix (10%), and new credit (10%).
Let’s look at how that last item, “new credit,” impacts your credit score: Just to be clear, VantageScore also considers inquiries in the “new account” category and counts them as “low impact” in determining your score.
This category includes the number of recently opened credit accounts and all new credit inquiries. Inquiries are made by lenders before approving your request and will remain on your credit report for two years. Inquiries have little to no effect on your credit score, and if they do, they will disappear after a few months.
Generally, lenders are most interested in new accounts, and if you don’t have any new accounts within a month or two of making an inquiry, the impact of the inquiry may be negated as there is no new debt associated and therefore no risk to the lender.
What is New Credit?
New credit is exactly what it sounds like: applying for a line of credit or a loan that you didn’t have before. Now, let’s take a moment to think about what new credit is not.
For example, say you have a credit card with a $5,000 limit. You spend $2,500 and have $2,500 of spending capacity left. Accessing some or all of the remaining $2,500 does not mean you are using new credit. The lender has already approved you for the limit, and it doesn’t matter how much or how little you use in this category. Of course, accessing credit in the ways we just mentioned will have a serious negative impact on the credit utilization portion of your score.
Let’s say you get an offer for a new credit card, loan, or line of credit from a lender. These pre-approved credit offers aren’t new credit either (unless you accept the offer). These offers are just pre-offers. You still need to formally apply for and be approved for the credit being sold to you.
When you decide to apply, your credit report and score will enter new credit territory. The “new credit” category is triggered any time you apply for credit that you didn’t have before. This includes credit cards, of course, but also auto loans and mortgages.
How do new credit accounts affect my score?
Applying for a new credit card or other line of credit can raise or lower your credit score. This depends largely on when the item is reported. It’s reported when the application is made, but delays in timing between application and approval and hard inquiries can temporarily lower your score.
While hard queries don’t have a significant impact on the average credit report, they can have a more severe negative impact on credit files with a short credit history or few entries. These files are also known as thin files. While they may not cause a significant drop in your score in terms of points, if you have a limited history and a low score, even a few points can affect a lender’s decision more than someone with a high score and extensive history.
But new accounts can also improve your score in a few ways. If you open a new credit card line but don’t access your credit, your utilization ratio and overall score will improve over time. Depending on how much credit you have, you might even access a small portion of your credit and see your utilization ratio increase because of the higher line of credit.
Finally, if your new account is a type of credit you didn’t have before (such as a car loan or other installment loan), it can help improve your credit mix, which accounts for 15 percent of your score. This is an often-overlooked strategy for improving your credit score, but it can be beneficial for those with thin credit files.
How do new credit inquiries affect my score?
An inquiry is simply a record that someone has requested your credit report for a legal purpose. This could be yourself, a credit provider, employer, insurance company, or lender. However, there are two types of inquiries: hard inquiries and soft inquiries. Here we will only be concerned with hard inquiries.
Hard inquiries are the result of applying for credit or other services. They pose a bit of a risk to lenders because they indicate that you may have additional debt that doesn’t yet show up as an account on your credit report. As such, they are shared with the lender and may have a slight impact on your credit score until the new account is added. You may see these listed on your report as “inquiries shared with others.” As mentioned above, only hard inquiries affect your credit score. This also means that you don’t need to worry about these pre-approval offers as they are called “soft” inquiries.
On your credit report, soft inquiries are only visible to you, not to others such as lenders. Also, soft inquiries do not affect your credit score or lending decisions. Examples of soft inquiries include pre-approved credit offers, requests for credit reports, requests by employers or landlords (with your permission), and requests for reports by insurance companies. These may be listed in a section called “Inquiries visible only to you.” None of these inquiries affect this portion of your credit score in any way.
When should I apply for new credit?
In short, only apply for new credit if you qualify for it and really need it. Always approach new credit with caution and have a plan for paying off your debt.
Even if your application is approved, you may not get as high a credit limit as advertised, as these offers will always include language stating that the offer you receive is not guaranteed and will be determined by the information in your credit report.
It pays to check your credit report regularly, and you can do so for free at AnnualCreditReport.com. You may also be able to access your scores and reports through your bank.
Conclusion
New credit has a big impact on your credit score, making up 10 percent of your FICO score, so it’s important to understand the difference between hard and soft inquiries and only apply for new credit when necessary.
Opening a new credit card or other line of credit may temporarily lower your credit score, but it will also improve your utilization rate and credit mix in the long run. Be sure to regularly review your credit report for accuracy and approach new credit carefully with a repayment plan. Knowing your credit information and maintaining your credit responsibly will help you maintain a healthy credit score and financial future.
