The short answer: It depends. It’s true, opening a new credit card can sometimes give your score a big boost. And sometimes it’s the best thing to do. But it’s certainly not a “one-size-fits-all” solution.
We commonly recommend opening additional accounts, including credit cards – but only for clients who don’t show enough credit history on their credit report. Before making this recommendation we look at how many open accounts are currently showing on the credit report. If a person already has 4 accounts, 2 of them being credit cards, then adding another credit card won’t really help the score all that much more. We’ll go through the exact details in a bit. Knowing the fundamentals can help you avoid taking wrong actions that can cause scores to drop.
“…since the customer already had 2 cards, opening another one wasn’t going to help the score.”
REAL NIGHTMARE
We had a customer who came to us after finding out she was 102 points short of qualifying for a home mortgage. Distressed and overwhelmed, she didn’t know what to do. She was referred to us and signed up for our credit repair service. Over the next 4 months, her score jumped up 93 points. She was ecstatic! However, she was still 19 points away from being “loan approved.”
After seeing the improvement, her loan officer told her to open a new credit card. He said that in 30 days or so, this should increase her credit scores by 20-30 points. (The customer already had 5 open reporting accounts – including 2 credit cards). The loan officer also advised her to use the credit card and leave a balance on it. He told her that by doing so, her new card would report to the credit bureaus at the end of the first billing cycle. Whoops…
Following the loan officer’s advice, the customer applied for a credit card with a local bank and was approved for a credit limit of $2000. After approving her, the creditor offered her a balance transfer promotion of 0%. It seemed like a no-brainer, since the customer had about $1500 of other credit card debt with higher interest. So, the customer did just that.
A month later the loan officer pulled a new credit report. After hearing that the new credit card had a 0% interest rate and that there was a new balance reporting, hopes were high. Unfortunately, anticipation quickly turned into confusion…and the customer’s hope turned into frustration and disappointment. Not only was there no score increase, but her scores dropped by 12 points!
What happened? First of all, the customer already had enough previous credit history, including 2 credit cards reporting. So, opening a new credit card was never going to boost the customer’s scores. Plus, whenever a balance transfer occurs, credit scoring formulas consider the new card balance as a new risk…even though the debt amount was previously on the credit report on an older established account. The bigger the new balance is, the bigger the risk. Any considerable amount of new debt is treated as a new risk, and it will drop the scores for about 4-12 months.
4 Checkpoints Before Opening a New Credit Card
1. Four is the Magic Number
The number of open accounts showing on your credit report is what contributes to the biggest category (35%) of your credit score – your “payment history.” Someone with 0 open accounts will greatly benefit from opening even 1-2 new accounts. Someone with 3 accounts will see a small score boost from opening a 4th. But once you have 4 or more open accounts, the score increase from adding more accounts is nominal. And considering the impact of the inquiry (about 4-10 points), it’s fairly common for scores to temporarily drop when adding a 5th or 6th open account. This is part of the reason why the customer in the example above experienced a score drop.
2. Variety Matters
Having 4 accounts is generally the goal, but it’s not the only thing that matters. Make sure you have enough variety of account types (e.g. installment loans, credit cards, utility accounts). According to Fair Isaac Corporation (the creator of credit scoring formulas), about 10% of your credit score is based on your variety of account types. After all, having a good variety of account payment history shows that you can handle a mixture of credit.
In the example above, the customer already had 2 open credit card accounts. That’s why we didn’t recommend opening another card. The loan officer did. But, since the customer already had 2 cards, opening another one wasn’t going to help the score.
Side note: whenever you apply for a new account, make sure it actually reports to all 3 of the credit bureaus. Some creditors report to just 1 or 2 of the 3 bureaus.
3. Applying the Knowledge – Don’t Open Unnecessary Accounts
Let’s apply all of the logic from checkpoints (1) and (2). Basically you want to end up with at least 4 accounts, but also have a variety of account types. That means two of the accounts should be credit cards.
Here’s an example of what you shouldn’t do:
Let’s imagine you already have 4 accounts and the right amount of variety (e.g. 2 credit cards, 1 car loan, 1 utility account). Then adding another account will initially hurt the score more than it helps it. Let’s understand the advantages and disadvantages of adding that extra, unnecessary account. Long Term Advantage: After 12+ months of making on-time payments, the new account will slightly start to help the score. Immediate Disadvantage: Adding an account generates a hard inquiry, which hurts the score for 4-6 months. Possible Immediate Disadvantage: If the new account includes a debt (e.g. new loan, new credit card with balance transfer), the new debt also affects the score! Depending on the size of the debt, that new account can drop scores for 4-12 months.
Instead, make the correct decision.
Look at these scenarios and see what applies to you:
- Scenario: You have no open accounts (that means no credit cards), and you have no credit score. Why? If you have no recent payment history (within the last 2 years), then you won’t have a score. Answer: Adding a credit card (even 2 cards) is a great idea! Just know that you won’t generate a score until you’ve made 6 monthly payments.
- Scenario: You have more than 4 accounts, but only have 1 credit card. (1 credit card, 2 loans, and 2 utility accounts). Answer: Opening another credit card could help the score a little (about 4 to 6 points).
- Scenario: You have less than 4 accounts, (1 credit card, 1 car loan and 1 utility account). Answer: Adding a 2nd credit card account will substantially improve your score (about 7 to 15 points).
- Scenario: You have more than 4 accounts, but have 2 credit cards. Answer: Opening more credit card accounts won’t immediately increase your scores – in fact, they will likely drop a bit. However, after 12+ months of on-time payments, the extra accounts will start to slightly help improve the score.
4. Be Careful When Adding Debt Onto a New Credit Card
In the customer example above, she opened a new credit card and took advantage of a balance transfer offer. Her actions resulted in a new card with a big new balance. Basically, it was like she took out a new loan (and any new loan is considered a new risk and initially hurts scores). Now, you may be thinking, “But the client transferred the debt from previous credit cards, which were showing on her credit report…all she did was transfer the debt, right?” True. It technically wasn’t new additional debt. However, credit scoring formulas place a lot of weight on the amount of debt on new accounts. Because the debt from a different card was being transferred onto a new card, the score suffered.
Care to Know Exactly How a New Loan Affects Credit Scores?
You need to consider 2 factors when trying to determine the score impact from a new loan (or new credit card debt):
- What is the amount of new debt?
- What does the overall credit report look like?
Here’s a couple real life examples:
Client A: One of our clients already had $50,000 of debt on his credit report. He got a new loan for $2000. This was a small amount compared to the existing debt on the report. So for him, the new $2000 loan dropped his score by only 5 points.
Client B: Now, on the contrary, we have another client with no loans and 1 open utility account. This client also got a new loan of about $2000 (engagement ring). However, because he didn’t have any debt on his report, this new loan dropped his scores by 40 points. Basically, anytime a new loan (or new credit card with debt) is added to the credit report, the score drops. Afterwards, credit scores can take anywhere from 4-12 months to recover, depending on the size of the loan.
