Why is my Credit Score Low After Getting a Credit Card?
Opening a new credit card can come with an exciting feeling, it can also improve your credit score temporarily. When a card issuer looks at your credit information because you’ve applied for a credit card, it is a so-called “hard pull.” That can lead to a slight drop in your credit score, whether you are approved or not.
You might then start to wonder why your credit is going low instead to increase after you got your credit card. Over time, though, getting a credit card can help build a better credit history if you pay it on time and carry minimal debt (basically using all your credit accounts responsibly). As you build up a history of responsible behavior, and it’s reported to the major credit bureaus, you can be on your way to a better financial future.
- Why Did my Credit Score Suddenly Drop?
- How Can Opening a New Credit Card Help my Credit Score?
- Can Opening a New Credit Card Hurt my Credit Score?
- How Much Does Credit Score Drop After Opening a Credit Card?
- How Many Points Does a New Credit Card Raise Your Score?
- What Should You Consider Before Opening a New Credit Card?
Why Did my Credit Score Suddenly Drop?
There are general guidelines you can follow to build your credit score. But what’s often overlooked are the actions you take that actually ding your score, even if you were doing something you thought was positive.
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The good news is that many credit score dings are temporary and can be easily recovered. And oftentimes, actions like paying off a loan or applying for a new credit card will benefit you in the long term once you get past the initial fluctuation.
Below are the five ways you may be causing your credit score to suddenly drop — whether you realize it or not.
1. You applied for a new credit card
Card issuers pull your credit report when you apply for a new credit card because they want to see how much of a risk you pose before lending you a line of credit. This credit check is called a hard inquiry, or “hard pull,” and temporarily lowers your credit score a few points. Hard inquiries remain on your credit report for two years, but FICO (which most lenders use) only considers inquiries from the last 12 months when calculating your credit score.
But hard inquiries on your credit report aren’t necessarily bad when they happen in moderation. After all, applying for credit cards is a great first step in building credit. When you use credit cards correctly — by charging purchases and paying them off in full by the due date — they can help increase your credit score. If you’re looking to build credit, consider the Petal® 2 “Cash Back, No Fees” Visa® Credit Card, which offers cashback, or the Capital One Platinum Credit Card which is designed for average credit applicants.
To reduce the number of unnecessary hard pulls on your credit report, check if you qualify for a new card by using issuers’ preapproval or prequalification offers. These won’t guarantee that you’ll be approved for the specific credit card, but they’ll give you a good idea.
When it comes to actually applying for new credit products, be sure to spread out your credit card applications over time. Only apply for a new credit card every three months, and maybe wait even longer between applications if you have a lower credit score.
2. You charged a large purchase onto your credit card
Credit cards are convenient for making large purchases because you don’t need to pay all the money upfront, but leaving a high balance on your card will report a higher credit utilization rate (CUR) to the credit bureaus.
Your utilization rate, or your debt-to-credit ratio, measures how much credit you use compared to much you have available. You want to aim for a low utilization rate because using too much of your available credit limit shows that you pose a financial risk to issuers. Experts recommend keeping your credit utilization below 30%, with some even suggesting below 10% to get the best credit score.
Before you charge a hefty expense onto your credit card, make sure you can pay it off in full before the billing cycle ends. Carrying a high balance on your credit card is not only bad for your credit utilization rate, but it will also incur a whole lot of interest.
3. You missed a credit card payment
Because your payment history is the most important factor that determines your credit score (making up35% of your FICO score calculation), missing a credit card payment will have an immediate negative effect on your score. Needless to say, lenders and issuers care a lot about whether you’ve paid your past credit accounts on time because they indicate your risk.
According to FICO data, a 30-day missed payment can drop a fair credit score anywhere from 17 to 37 points and a very good or excellent credit score to drop 63 to 83 points. But a longer, 90-day missed payment drops the same fair score 27 to 47 points and drops the excellent score as much as 113 to 133 points. In other words, the higher your credit score, the greater the negative effect will be.
How quickly your score bounces back after a missed payment varies depending on your credit history and your payment behavior after you miss a payment. If you jump back on track quickly after, it’s likely your score will start improving along with your good payment history. A history of on-time payments is vital to a good credit score, and it’s even better if you can pay them in full.
4. You paid off a loan
While paying off your credit card debt can increase your credit score, paying off installment debt, such as a mortgage or a student loan, has the opposite effect.
Paying off something like your car loan can actually cause your credit score to fall because it means having one less credit account in your name. Having a mix of credit makes up 10% of your FICO credit score because it’s important to show that you can manage different types of debt.
Don’t let this prevent you from paying off your loans, however. Being debt-free will help your overall financial health, and it makes no sense to pay unnecessary interest charges overtime just to save a few credit score points.
5. You closed your credit card
Closing a credit card account, especially your oldest one, hurts your credit score because it lowers the overall credit limit available to you (remember you want a high limit) and it brings down the overall average age of your accounts. The length of your credit history makes up 15% of your FICO score, which is why experts recommend building credit at a young age. The longer you can show you have had credit, the better for your credit score.
The exception to this is if you are paying for a credit card that you no longer use. In today’s world where travel is nearly nonexistent, that may mean closing your luxury travel credit card with a steep annual fee, like the Chase Sapphire Reserve®, which new cardholders pay $550 per year for. It could also mean closing the secured credit card that you paid a deposit for to receive a credit limit, such as with the Capital One Platinum Secured Credit Card.
Before closing your card, talk to your issuer and see if you can either downgrade to a no annual fee card or, in the case of a secured card, upgrade to an unsecured credit card. This could help you preserve the credit line so that it doesn’t show up as being closed on your report while getting you a card that’s better suited for your needs.
How Can Opening a New Credit Card Help my Credit Score?
Responsible handling of your finances, potentially with the opening and use of a credit card, can help build a good credit history over time. For example, while FICO® Scores are made up of several components, one important category is amounts owed, which typically makes up 30 percent of your overall score. This component addresses your debt-to-credit ratio, or credit utilization rate.
Essentially, it measures how much of the credit extended to you, also known as your credit limit, is being used and paid off. Per FICO, a low credit utilization rate will more positively affect your FICO® Scores than not using your available credit at all because it shows that you are capable of handling credit responsibly.
How many credit cards do you need to build credit? The answer depends on your credit utilization and how much credit you need, so consider the ratio of how much you spend compared to how much credit is available to you on your card, or cards. For example, opening a credit card may lower your debt-to-credit ratio.
Say that you double your total credit lines available from $5,000 to $10,000 by opening a second card, but you simply spread out your current spending of about $1,000 per month across those two credit cards. This would improve your utilization ratio, meaning that you’re spending $1,000 out of $10,000 available to you, for utilization of 10 percent instead of 20 percent when you had $5,000 available.
But remember, using more credit could make you less likely to pay back what you’ve borrowed. A high utilization ratio fits the profile of someone who might be “living on credit.” That’s a fiscally dangerous way to live, and a higher risk for potential lenders. Whenever possible, you should try not to use all your available credit.
Can Opening a New Credit Card Hurt my Credit Score?
Despite all of the ways that a new credit card can help your credit score, there’s always the potential for it to hurt your score under certain circumstances.
For example, if you were to open up several new lines of credit in a short period of time, you may see a drop in your FICO® Scores. Applying for several new credit cards could be seen as a sign of riskier spending, and the credit scoring formulas could penalize consumers for opening multiple accounts within a few months’ time.
Also, if having a new credit card account leads to incurring more debt and the potential to exceed your credit limit, then your credit score also can suffer. And if having too many accounts causes you to make late payments, then that could hurt your credit score.
Another way that getting a new credit card can hurt your credit is if you use a balance transfer offer to transfer the balance of a loan to your new credit card, which can increase your debt-to-credit ratio and reduce your mix of credit.
Finally, opening a new credit card will reduce the average age of your accounts, especially if you have few credit cards and they have all been open for a long time. Having a low average age of accounts is a factor in having a low credit score. About 15% of your FICO® Score is determined by the length of your credit history.
How Much Does Credit Score Drop After Opening a Credit Card?
Almost every time you apply for a credit card, you will receive a hard inquiry on your credit report. There are some exceptions, such as the fact that American Express often won’t inquire about existing customers until the new application is approved. While the exact impact may vary from case to case, generally speaking, you can expect your score to drop by about five points each time you apply for a new credit card.
This might seem scary if you’ve been working to improve your credit score for a long time, but it’s important to remember that the exact number is rarely what banks look at when evaluating your application. They’ll put you into a range, say, 700-750 — so if your score drops from a 740 to 735, it is unlikely to have any real effect on future approval odds.
Having too many recent hard inquiries can drag down your score. Credit Karma says that your score starts to be impacted with three to four recent inquiries, but especially once you get above five. The inquiry will stay on your credit report for up to two years, but the impact fades over time. If you see a jump in your credit score one month that’s not linked to any obvious event, such as paying off a balance, it may be the effect of your inquiries fading in relevance.
How Many Points Does a New Credit Card Raise Your Score?
If you’re thinking about opening a new credit card and are wondering whether it will help your credit score, the answer is yes—and no.
Let’s look at how a new credit card might help you improve your credit score:
- Increase available credit: Opening a new credit line increases your available credit, which can positively affect your credit score. The key is to keep the balance relatively low so your available credit stays high. This is known as your credit utilization rate, and it’s best to keep your overall credit usage under 30%. For the best impact on your scores, keep your credit utilization as low as possible.
- Improve credit mix: Your credit mix refers to the different types of accounts you have in your credit file. There are many types of debt accounts and two broad categories: installment credit and revolving credit. Installment credit refers to loans you take out and repay a single time, such as mortgages, car loans and personal loans. Revolving credit refers to accounts you can charge a balance on, repay and reuse, such as credit cards and home equity lines of credit. Credit mix makes up 10% of your score, so opening a new credit card may be helpful if most of your existing accounts are installment loans. That said, avoid opening a credit card solely to diversify your credit accounts.
- Opportunity to establish strong payment history: Payment history comprises 35% of your credit score, making it the No. 1 influence on your credit. When you open a new credit line, you have a chance to build up a history of on-time payments by paying your bill by the due date every month.
What Should You Consider Before Opening a New Credit Card?
1. Four is the Magic Number
The number of open accounts shown 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.
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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 To 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.