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Key takeaways
- New credit refers to recently opened credit accounts and inquiries from lenders.
- Applying for new credit can have temporary negative effects on your score, but it can also improve your utilization and credit mix.
- Only apply for new credit when it is necessary, and regularly check your credit reports for accuracy.
The FICO credit score is made up of five key components: payment history (35 percent), credit utilization (30 percent), credit history (15 percent), credit mix (10 percent), and new credit (10 percent).
Let’s delve into the significance of the last component — new credit — on your credit score. It’s worth noting that VantageScore also takes into account inquiries under the “new accounts” category, considering them as “less influential” in determining your score.
This category encompasses the number of recently opened credit accounts and all new credit inquiries. The inquiries are those made by lenders prior to approving your request and will show up on your credit report for two years. While they have minimal impact on credit scores, any effect typically dissipates after a few months.
Generally, lenders are primarily interested in new accounts. If no new account is opened within a month or two following the inquiry, the inquiry’s impact is likely to diminish, as it poses no risk to the lender without any associated new debt.
What is new credit?
New credit simply refers to credit lines or loans that you applied for and did not previously have. Let’s take a moment to clarify what new credit is not.
For instance, if you have a credit card with a $5,000 limit and use $2,500, leaving $2,500 available, accessing the remaining credit is not considered new credit. Your lender has already approved your limit, regardless of how much you use. However, utilizing the credit as described here can negatively impact the credit utilization aspect of your score.
Similarly, receiving preapproved credit offers from a lender for a new credit card, loan, or line of credit does not constitute new credit (unless you accept the offer). These offers are preliminary and require formal application and approval to materialize into new credit.
Once you apply for credit and it is approved, you enter into new credit territory concerning your credit reports and score. The “new credit” category is activated whenever you apply for credit that was not previously in your possession, including credit cards, auto loans, and mortgages.
How does new credit impact your score?
Upon applying for a new credit card or line of credit, you may observe either an increase or decrease in your credit score, depending on when the items are reported. The duration between application and approval reporting may cause a temporary score dip due to the hard inquiry.
While hard inquiries do not significantly affect the average credit report, they can have a more pronounced negative influence on a credit file with limited history or few entries, also known as thin files. Although the decrease in points may not be substantial, it could potentially impact a lender’s decision more for individuals with a low score and limited history compared to those with a high score and extensive history.
On the flip side, new accounts can positively impact your score in various ways. For instance, opening a new credit card line without utilizing the credit can enhance your utilization and overall score over time. Additionally, accessing a portion of the credit may increase your utilization due to the higher credit lines available.
Moreover, if the new account falls under a credit category you did not previously possess (such as a car loan or installment-type loan), it can improve your credit mix, constituting 15 percent of your score. Enhancing your credit mix is an often overlooked strategy for boosting your credit score, particularly beneficial for individuals with thin credit files.
How do new credit inquiries affect your score?
Inquiries represent instances where someone with a permissible purpose requests your credit report under the law. These requests can come from credit grantors, employers, insurance companies, lenders, or even yourself. There are two types of inquiries — hard and soft, with only hard inquiries impacting your score.
Hard inquiries stem from credit or service applications, suggesting potential additional debt not yet reflected in your credit report. As they present a degree of risk to lenders, they are shared with lenders and can marginally affect your credit scores until the new account is added. These inquiries may appear on your report as “inquiries shared with others.” Soft inquiries, on the other hand, have no impact on credit scores and are only visible to you, such as preapproved credit offers or requests for your credit report.
When should you apply for new credit?
In essence, only seek new credit when you are certain of qualification and genuine necessity. Approach any new credit application thoughtfully and have a repayment plan in place.
Upon approval, you may not receive the exact credit line advertised, as the offer is contingent on the information in your credit report. Stay vigilant by regularly monitoring your credit reports, which can be done for free at AnnualCreditReport.com. Some banks also provide access to scores and reports.
The bottom line
New credit plays a significant role in your credit score, accounting for 10 percent of your FICO score. Thus, it is crucial to differentiate between hard and soft inquiries and apply for new credit only when necessary.
Despite potential temporary score decreases upon opening new credit accounts, they can ultimately enhance your utilization and credit mix. Stay proactive by regularly verifying the accuracy of your credit reports and approaching new credit applications responsibly with a repayment strategy. By staying informed and prudent with your credit management, you can maintain a healthy score and secure financial future.