Welcome to the “2-Minute Money Manager,” a short video feature answering money questions submitted by readers and viewers.
Today’s question is about credit cards and credit scores; specifically, whether having lots of credit cards will damage your score.
Watch the following video, and you’ll pick up some valuable info. Or, if you prefer, scroll down to read the full transcript and find out what I said.
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For more information, check out “The 6 Best Credit Cards This Spring” and “4 Reasons You Should Switch Credit Cards.” You can also go to the search at the top of this page, put in the words “credit cards” and find plenty of information on just about everything related to this topic.
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Got a question of your own to ask? Scroll down past the transcript.
Don’t want to watch? Here’s what I said in the video
Hello, and welcome to your “2-Minute Money Manager.” I’m your host, Stacy Johnson, and this answer is brought to you by Money Talks News, serving up the best in personal finance news and advice since 1991.
Today’s question comes from Ramsey:
“I desire to add several credit cards for increased bonus air miles. My wife fears that those extra credit cards will hurt our credit score. What is the truth?”
This question isn’t a straightforward as it seems, because adding new credit can affect you in both the short and long term.
In the very short term, opening a new account will cost you a couple of points on your credit score. Why? Because getting approved for a credit card requires a “hard pull” of your credit profile by the card issuer. This happens every time you apply for a loan or credit card, and is the reason you might see your credit score drop a few points after a credit card or loan approval.
A soft pull, on the other hand, has no effect — positive or negative — on your credit score. Examples of soft pulls would be when you check your own credit, or when a credit card company checks your credit before offering you plastic.
Generally, the drop in your score from a hard pull is marginal. That said, it’s worth noting that a hard pull of your profile remains on your credit report for up to two years before falling off, although it shouldn’t affect your score after six months or so.
Bottom line? In the short term, Ramsey’s wife is right to be at least a bit concerned. Applying for credit cards can negatively affect your score. Other things to consider:
- Be selective. Since pulling your credit profile could cost you some credit score points, try to only apply for cards you have a good chance of qualifying for. There is no point in losing points for cards you weren’t going to get anyway.
- We’re not all alike. Those with high credit scores and solid credit histories will lose fewer points than those with lower scores and spotty histories.
- About to borrow big? Be careful. If you’re going to be applying for an important loan within the next six months — think car loan or mortgage — don’t take a chance on losing points by applying for additional credit now. Lost points on a credit score could cost you tens of thousands on a mortgage. On the other hand, if a big loan request isn’t in your future, it’s probably not a big deal.
The long-term effects of opening a new credit card account can be positive, assuming you make on-time payments each month and keep your balance low. In fact, opening a new credit card account improves your score in more ways than one:
1. Improves your payment history. According to FICO, more than one-third of your credit score is made up of your payment history. A pristine payment history means zero late or missed payments. The longer you go without missing a payment, the better your credit score will be. Adding a new card and making on-time payments each month will enhance your payment history, and thus your score.
2. Extends your available credit line. FICO has said that the second-most-important factor when determining your credit score is your credit utilization ratio. This is the amount you owe relative to your total available credit line.
When you add a card to your credit profile, you’re extending your total available credit line and thus lowering that all-important credit utilization ratio. Ideally, you want to keep this ratio as low as possible: 10% to 30%. If you keep it at 10%, for example, that means if you have a total credit line of $1,000, you should never owe more than $100. This is another reason why it’s extremely important to keep your credit card balance low.
3. Diversifies your credit profile. Finally, opening a new credit card account diversifies your profile, especially if you haven’t had a credit card before. Having different types of credit — credit cards, home or car loans — is another factor that can raise your credit score.
While you might see an initial drop in your credit score upon approval of a new card, the long-term positives can outweigh the short-term negatives associated with opening a credit card account, providing you won’t need to apply for a mortgage or car loan for six months or more.
If Ramsey has great credit and no plans to borrow big anytime soon, why not apply for cards that offer big sign-up bonuses?
In fact, I recently did that myself. A couple of months ago, I signed up for a new card that, after spending a few thousand dollars within the first few months, paid 100,000 reward points. That’s enough for a week’s worth of hotel stays.
As long as I pay the card off every month — and I most definitely do — what’s not to like?
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The questions I’m likeliest to answer are those that will interest other readers. In other words, don’t ask for super-specific advice that applies only to you. And if I don’t get to your question, promise not to hate me. I do my best, but I get a lot more questions than I have time to answer.
I founded Money Talks News in 1991. I’m a CPA, and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate.
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