Many people are wary of applying for a new credit card because they’ve heard that their credit score takes a hit when they do it.
Here’s the real scoop: Those folks aren’t wrong. They just don’t know the full story.
The truth is that if you play your cards right (pun intended), that credit score ding (typically about five points that lasts two years) will hardly even matter. It will be outweighed by the new card’s positive effects on your credit score, which result primarily from your credit utilization rate.
Your credit utilization rate is a comparison of how much you owe to how much available credit you have. Let’s say that you have a $3,000 balance on your credit card and $5,000 of available credit. Your credit utilization rate is 60 percent, which is far higher than it should be. That matters because utilization is the second most important factor in the FICO credit-scoring formula, making up 30 percent of your credit score. Only your payment history, at 35 percent, is more important to your FICO score. (While there are many different credit-scoring formulas out there, the FICO score has long been considered the gold standard of credit scores and is still the score most commonly used by lenders.)
[See: 12 Habits to Help You Take Control of Your Credit.]
Job No. 1 for anyone with a credit card is to pay off your balance every single month in full, making your utilization rate a perfect zero percent. If you can’t do that — and many of us can’t — most experts recommend that you keep your credit utilization rate at 30 percent or lower.
But if your credit utilization rate is unacceptably high, how do you improve it? The best and most obvious way is to reduce what you owe on your credit cards. Of course, that’s much easier said than done. Otherwise, we’d all have zero balances.
The other option is far easier: Instead of shrinking your balance, grow your available credit. You can do that either by applying for a new credit card without canceling any of your current credit cards or by asking your current credit card issuer to bump up your credit limit. (Your chances of the bank honoring your request are likely far better than you think. A recent CreditCards.com survey found that 89 percent of cardholders who asked for an increased credit limit got their wish, but just 28 percent of cardholders had ever asked.)
[See: 12 Simple Ways to Raise Your Credit Score.]
Referring back to our earlier scenario, here’s how this would work:
— Say that you have one card with a $3,000 balance and $5,000 of available credit. Your credit utilization rate is 60 percent. Again, that’s not ideal.
— You then get a second credit card with $5,000 of available credit. That new card, with a zero balance, combined with your previous credit card, lifts your total available credit to $10,000.
— Assuming that your balance doesn’t grow, that shrinks your overall utilization rate to just 30 percent. ($3,000 is 30 percent of $10,000)
That major change would have a real impact on your credit score. It’s difficult to quantify exactly what that impact would be — there are simply too many variables to give a one-size-fits-all answer — however, it would certainly be larger and longer lasting than the small, temporary hit you would take for applying for the credit card.
The move isn’t without risk, however. Here’s why:
— Length of accounts: That new credit card would reduce the average age of your accounts — a less important aspect of your FICO score, at 10 percent, but a factor nonetheless — which could lower your score a bit in the short term. It would likely not be enough to undo the good from the improved utilization rate, however, especially if you don’t cancel any of your other credit cards in the process.
— Increased temptation: If you can’t resist the lure of that extra available credit, don’t get the new card. Focus on paying down your current balance instead.
— Too many cards to handle: If you suspect that you’re not organized enough to handle making on-time payments on more than one credit card, stick with just the one credit card you have. The last thing you want to do is to get in over your head and make mistakes with your credit. After all, one late payment can hit your credit score so hard that it outweighs all the good done by the new credit card. Be careful.
[See: 10 Easy Ways to Pay Off Debt.]
The bottom line is that no one should ever take getting a new credit card lightly. We never know what the future holds, and risk is present every time you sign on the dotted line. However, there’s also tremendous risk in not taking action to improve your credit score. Crummy credit can cost people thousands of dollars during their lifetimes in the form of higher interest rates and fees on mortgages, auto loans and other consumer debt. Getting a new credit card is one of the easiest and best ways to turn that crummy credit score around — as long as you know what you’re getting into and you handle your business properly.
More from U.S. News
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How a New Credit Card Can Boost Your Credit Score originally appeared on usnews.com
